How much cash on hand should one have?

Question

The basic question is how much of my 'money' should I have on hand (ready to spend immediately) as opposed to putting it all in a high-yield (or at least inflation-fighting) investment?

For instance, I currently budget 500 in 'cash' (in my bank's checking account) and the rest of my 'un-budgeted income goes into Scottrade and I personally manage my 'short-term/intermediate term' savings that way via stocks. I sleep well knowing that I do have a credit card buffer (1.5k) and of course xx,xxx dollars in stock positions that are no more than 3 business days away should I need them.

My bills are pretty cheap as I live a minimalistic lifestyle and I get paid bi-weekly. On payday, I set aside 500 for the two weeks (groceries/hobbies/etc) and if any reoccouring bills are due before next payday I pay them. Then, I toss the rest into Scottrade.

My problem is that I hate 'wasting' the opportunity cost! I know you should never "risk more than you can afford to loose" but at this point in my life the money I personally invest is not super 'necessary for my life' (I already have a decent employer paid retirement account and manage a ROTH IRA).

If I do what some people say and keep 3, 6, or a year's worth of bills on hand that's a significant chunk of change being lost every day in missed interest...

Of course the worst case scenario would be that I lose all my positions' value and my job and perhaps lose my arms (I'm a software engineer) and perhaps even am stuck with a huge bill somehow, but what are the odds that that (or any of that) will happen. [admittedly more than I'd like to think but you get my point]

So, what is a good amount/percentage of cash to have on hand (after bills are paid/accounted for)?

Am I just being naive (I'm in my early 20s) or what?

update I am flexible with the 'cash on hand' amount. For instance, for about three months I put a very tight spending/investing freeze on my life because I knew I'd be leaving jobs and moving (I already had the other job lined up). Once I moved and settled in, I eased up and am back to my 'pre-life-changing-event' budget mode.

Is my overall model fine? How much of a risk am I taking? I'm no stranger to risk, but tend to know my enemy (and keep her close;)

Answer 1

You seem to have a grasp of the basic principles involved, but your estimation of the risk you are taking seems a bit low. Your non-investment reserves are unlikely to cover your expenses for more than a month, so the chance that you would need to sell investments to cover additional expenses is high. You mention that

I am flexible with the 'cash on hand' amount. For instance, for about three months I put a very tight spending/investing freeze on my life because I knew I'd be leaving jobs and moving (I already had the other job lined up).

Those savings presumably went toward moving expenses, as your usual savings were insufficient. In the event that you are laid off suddenly, you might find yourself in the same position again, with added unplanned expenses like fees for breaking a lease.

Your current plan involves selling investments to cover the gap. Based on your age you have probably only invested in a predominantly positive market, so the chance that you might need to sell investments for cash seems like a reasonable trade-off for the added potential gains. Your perception might change if the markets go south and you are forced to sell into a down market, possibly at a significant loss. You also don't indicate if your investments are currently sufficient to cover an extended period of unemployment.

You are taking on a lot of risk under your current plan. Essentially you are trading possible investment gains for flexibility and time. By making small changes like saving at least enough to move as you did previously, you can give yourself time to react to job loss or other unexpected financial need. Rather than give the traditional emergency funds advice, I suggest you look at the broader picture. The total amount of savings/risk is up to you, but you should consider your current savings as insufficient to rely on as a safety net.

Answer 2

There are two or three issues here.

One is, how quickly can you get cash out of your investments? If you had an unexpected expense, if you suddenly needed more cash than you have on hand, how long would it take to get money out of your Scott Trade account or wherever it is? I have a TD Ameritrade account which is pretty similar, and it just takes a couple of days to get money out. I'm hard pressed to think of a time when I literally needed a bunch of cash TODAY with no advance warning. What sudden bills is one likely to have? A medical bill, perhaps. But hey, just a few weeks ago I had to go to the emergency room with a medical problem, and it's not like they demanded cash on the table before they'd help me. I just got the bill, maybe 3 weeks after the event. I've never decided to move and then actually moved 2 days later. These things take SOME planning. Etc.

Second, how much risk are you willing to tolerate? If you have your money in the stock market, the market could go down just as you need the cash. That's not even a worst case scenario, extreme scenario. After all, if the economy gets bad, the stock market could go down, and the same fact could result in your employer laying you off. That said, you could reduce this risk by keeping some of your money in a low-risk investment, like some high-quality bonds.

Third, you want to have cash to cover the more modest, routine expenses. Like make sure you always have enough cash on hand to pay the rent or mortgage, buy food, and so on.

And fourth, you want to keep a cushion against bookkeeping mistakes. I've had twice in my life that I've overdrawn a checking account, not because I was broke, but because I messed up my records and thought I had more money in the account than I really did.

It's impossible to give exact numbers without knowing a lot about your income and expenses. But for myself: I keep a cushion of $1,000 to $1,5000 in my checking account, on top of all regular bills that I know I'll have to pay in the next month, to cover modest unexpected expenses and mistakes. I pay most of my bills by credit card for convenience --and pay the balance in full when I get the bill so I don't pay interest -- so I don't need a lot of cushion. I used to keep 2 to 3 months pay in an account invested in bonds and very safe stocks, something that wouldn't lose much value even in bad times. Since my daughter started college I've run this down to less than 1 months pay, and instead of replacing that money I'm instead putting my spare money into more general stocks, which is admittedly riskier. So between the two accounts I have a little over 2 months pay, which I think is low, but as I say, I'm trying to get my kids through college so I've run down my savings some. I think if I had more than 6 months pay in easily-liquidated assets, then unless I expected to need a bunch of cash for something, buying a new house or some such, I'd be transferring that to a retirement account with tax advantages.