How Much Cash To Hold In Retirement

As you create a financial plan, major concerns about how much to save, how much you will be able to withdraw from savings each year, how long will your savings last, etc. often take center stage. One consideration that doesn't get as much attention is how much of your savings should be kept in cash. Before you retire, a common rule of thumb is to always have at least six months expenses in cash. This is mainly to help protect you if you should lose your job,
or incur significant unexpected expenses. But is this enough after you retire?

The good news - once you retire you no longer have to worry about being unemployed! The bad news - that concern quickly gets replaced with what will happen if most of your savings are invested - even conservatively - and the financial markets experience a sustained downturn. If you are planning to spend 20 - 30 years in retirement that's a very real possibility. It may even happen several times. A few examples:

•  From early 2008 to early 2009 the S&P 500 dropped by 50%. It took 4 years to get back to the previous high.

• In early 2018 (5 years after recovering from the last major market decline) the S&P 500 dropped by ~11%. It regained its previous high in a few months, only to decline ~19% from there by the end of the year. It took almost a year to get back to its previous high.

•  Due to COVID, on March 16, 2020, the Dow fell almost 3,000 points, or nearly 13 percent, for its largest point decline ever, and largest single-day percentage drop since the 1987 crash. By March 23rd, the S&P 500 had fallen 34%. The markets recovered late that year, but you certainly would not have wanted to be forced to sell any investments (to pay expenses) during that downturn.

• In 2022 the S&P 500 fell ~27%, recovered somewhat, but still ended down ~23% for the year. This was only 4 years after a similar sustained decline. The S&P 500 took 2 years to regain its previous high, doing so at the very beginning of 2024.

• The markets spent 2023 trying to recover from the 2022 loss, and it turned out to be a positive year in the end, but at one point  the S&P 500 still fell by 11% over several months. It sounds great to say that the S&P 500 gained 25% in 2023, but if you were invested since 2022 you just got back to even! Glass half full, or glass half empty?

Being aware of your risk tolerance should help to determine your investment allocations, but there's no way of knowing when a market downturn will occur, how severe it will be, or how long it may last. Prepare for the inevitable, and allow yourself the comfort of not having to make rash decisions at difficult times, by keeping enough cash on hand to withstand a sustained market downturn. Not only will it provide some peace of mind and spare you from selling investments at a low point, it can also keep you from having to take distributions from a 401k/IRA, and paying taxes on those distributions, at a time when your investments may be generating less income, or just plain declining in value (at least on paper).

While you should have a separate plan for how to manage your investments in different situations, a prudent precaution in retirement is to always have 2-3 years worth of expenses (less any reliable income, such as Social Security) in cash, or in a highly liquid account. Having to sell investments when they are at a low point to generate cash/pay expenses is a double whammy. Not only will you have to sell more shares to generate the cash that you need, but then owning fewer shares means that it will take longer for your investments to get back to their prior value.