As Americans, we have abundant opportunities to grow our wealth. Credit is accessible, the stock market offers the potential for compounding gains, and real estate provides a way to hedge against inflation and generate passive income. As your portfolio grows, it can be tempting to stay fully invested, keeping only a small cash reserve to cover living expenses. After all, staying invested over the long term is often seen as the key to building wealth. And with inflation eroding the value of cash, why keep money uninvested?
Additionally, it’s not as though your cash savings have to sit in a zero-interest account. At the time of writing, many savings accounts offer rates above 4%. Liquidity refers to how quickly you can access your funds without losing their value. This means that your reserves don’t have to be strictly in cash format in a savings account; they can also include other liquid investments like Treasury bills and money market funds.
While these options aren’t as immediately accessible as cash, they still offer higher liquidity than long-term investments such as stocks, bonds, or real estate. By structuring your short-term asset allocation thoughtfully, you can help ensure access to funds when needed while still earning a return on your cash.
In short, there are compelling reasons to keep a meaningful portion of your portfolio in liquid assets. In this article, we’ll explore practical, though general, guidelines for the amount of cash reserves to keep on hand and why they matter.
If you’re a business owner, your needs may differ, so our next article will cover cash reserves tailored specifically for businesses.
Cash Reserves as a Financial Cushion
The most immediate reason one should consider having a sizeable cash reserve is to cover unexpected expenses. In general, a good starting point is to set aside 3-6 months of living expenses, but the exact amount depends on your personal circumstances, portfolio mix, and comfort level with risk. For example, if you have a family, you’ll likely feel more at ease with having closer to six month’s worth of savings. On the other hand, if you’re single, perhaps three months’ worth of expenses is more than enough.
Additionally, having reserves in place reduces the risk of having to sell assets under unfavorable conditions. For instance, if an emergency arises during a market downturn, you may be forced to sell a portion of your portfolio at a depressed value.
By selling rather than holding until the markets recover, you lock in losses and miss out on the potential growth those stocks could have provided, permanently reducing the overall value of your portfolio, assuming that portion of your portfolio would have recovered.
Cash Reserve Levels for Real Estate Investors
The amount you should keep in cash depends greatly on the types of assets in your portfolio. Investors who hold illiquid assets, like real estate or private equity, are more likely to benefit from larger cash reserves. Let’s imagine you’re the owner of an apartment complex. Firstly, you’ll likely need cash on hand to pay for the inevitable broken boiler, washing machine, or damages to an apartment. Plus, you’ll want extra cash on hand to cover months without a tenant or tenants.
Alternatively, you might need the cash from selling the property, but if housing prices have declined, you’d likely prefer to wait for a market recovery. Without adequate cash reserves, however, holding off may be challenging. Sizable cash reserves can help cover expenses while you wait for a favorable time to sell. Additionally, remember that selling such assets can take time, so relying solely on proceeds from a sale may not always be feasible.
That’s not to say you need to hold only cash that you can pull from an ATM at a moment’s notice. Let’s say you’d like twelve months’ worth of reserves to cover maintenance, taxes, and insurance in case you end up with empty apartments. You might keep around, for example, fifty percent in cash and the rest in assets like a CD ladder or a money market fund.
Cash Reserve Allocation
This way, some of your savings earn interest to help offset inflation while still keeping enough cash on hand for immediate expenses—and knowing that the rest is easily accessible if needed. A financial advisor can help you determine an amount based on your unique situation.
Cash Reserves as an Opportunity Fund
Cash reserves aren’t just about preparing for emergencies or having a financial cushion. They also enable you to take advantage of unexpected investment opportunities. Imagine you’ve been considering investing in a rental property, but prices in your area have been high. Then, an economic downturn strikes, local property values decline, and a well-maintained property in a desirable location becomes available at a reduced price. Thanks to your cash reserves, you’re able to make a competitive offer quickly, securing the property before prices rebound.
However, this doesn’t mean completely waiting to invest until prices are down, as timing the market is rarely effective. However, having the freedom to invest when potentially lucrative opportunities arise has its own merits that shouldn’t be ignored.
Liquidity in Estate Planning
Liquidity needs may even extend into estate planning. If your estate is worth more than the estate exemption limit, your estate will have to pay taxes upon your passing. Without cash reserves, the executor will have to figure out how to pay those taxes, which could mean the sale of assets that were meant for your heirs, possibly in unideal market situations.
In 2024, the federal estate tax exemption is set at $13.61 million per individual, allowing married couples to shield up to $27.22 million from federal estate taxes. However, with the Tax Cuts and Jobs Act (TCJA) set to expire at the end of 2025, this exemption is expected to revert to around $5 million per individual in 2026, adjusted for inflation. Additionally, many states impose their own estate taxes with exemption limits that are often significantly lower than the federal threshold. Oregon, for example, has quite a low exemption limit of $1,000,000, while some states, like Florida and Texas, don’t have an estate tax at all.
In Conclusion
As your portfolio starts growing, it may seem psychologically difficult to let a significant amount of cash just sit in a savings account, letting inflation chip away at it. First of all, your savings account will earn you interest, helping to offset inflation. Secondly, the losses you may incur–or the opportunities you may have to pass up– due to not having any cash reserves serves as a strong argument for keeping sufficient cash on hand or at least a mix of cash and liquid investments.
This isn’t only the opinion of one wealth management firm either; According to a U.S. Trust survey of affluent Americans, investors with over $3 million in investable assets typically keep about 15% of their portfolios in cash and cash equivalents. Given their level of wealth, it’s reasonable to assume these investors have sufficient reasons for maintaining a substantial portion of their portfolios in cash.
Naturally, the question is exactly how much cash one should maintain, and it’s not a one-size-fits-all answer. That’s why sitting down with a financial advisor to determine a realistic figure is advisable. A professional perspective can help you strike the right balance between liquidity and growth, preparing you for both planned and unexpected financial events.
