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 facet that doesn't get as much attention is how much money 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. The last major downturn (lasting more than a few months) was in 2008, when the S&P 500 dropped by 50% over the course of a year. Once it bottomed, it took 4 years to get back to the previous high. From October 2018 to December, 2018 the markets dropped by ~20% and are just nearing their previous high as this is being written. Significant downturns typically last 6 - 10 months, but can continue for much longer. 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 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 you need, but then owning fewer shares means that it will take longer for your investment to get back to its prior value.

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.

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