We’re living through some bumpy economic times. On the one hand, inflation is — and has been — much higher than we’ve gotten used to. On the other hand, the investing markets are a-swinging. Even when the economy is relatively calm, and even if your risk tolerance is high, it’s a good financial wellness practice to stash away the right amount of money in cash. But now, regardless of how “cautious” or “risky” you tip, the advice is more urgent.
When the question is how much cash you should keep in the bank (vs investing it), there’s a familiar formula to follow: you don’t want too much (or too little) money in cash, and there’s a “just right” amount for everyone based on your budget and financial goals.
Before you make any money moves to determine that sweet spot of how much you should keep in cash, let’s get on the same page with some key financial terms, like what we really-really mean when we say “cash”.
What does it mean to keep money “in cash”?
In the world of personal finance, “cash” doesn’t usually mean literally cash, like the green stuff you can physically hold in your hand (or hide under your mattress, stash in the cookie jar, etc). Instead, it tends to mean that the money lives in your checking or savings account. Both of those bank accounts should be NCUA- or FDIC-insured in order to protect your money in the unlikely case of this. Most bank accounts are covered, but with the rise of digital banks, it’s worth making 100% sure.
Ideally, you’ll have both types of accounts, plus a plan for how much money to keep in your checking account and how much to keep in savings. And for good reason.
Why does it matter how much you keep in cash?
The point of keeping money in cash is stability and liquidity. Imagine this scenario: you lose your job. Or, a financial emergency pops up and you need money now. If you have too little saved in cash, you could find yourself in the really hard place of using your credit card to get by, or stressing over how to cash out of your investments. It might take time you don’t have — or make a financial impact you don’t want, like triggering taxes. For financial security, keep some cash in the bank.
Double emphasis on some, because there are good reasons not to keep too much money in cash, too.
Inflation decreases the value of any money you hold in cash. Inflation, aka rising prices over time, reduces your purchasing power. That $10 bill could have bought you a whole sandwich a few years back. Today, the sandwich costs $12.50, so the same $10 bill only buys you 80% of the sandwich. Even if inflation were at the government’s “target” rate of 2%, the interest you’d earn on your savings account just wouldn’t be able to keep up. And now, with inflation above 8%? No chance.
Investing for the long term gives you an opportunity to earn higher returns. In fact, the stock market has returned an annual average of 10% since 1928 — way higher than any savings account interest rate, even the “high-yield” ones. And that makes a big difference: The gender investing gap (men tend to invest 40% of their money, whereas women tend to invest just 29%) is one of the leading causes of the gender wealth gap.
Of course, investing always comes with risk. Especially when markets are volatile, it can be tempting to pull money out of your investment portfolio and wait for things to “calm down.” But that comes with its own risk, too — nobody knows what will happen tomorrow, and if you stop investing, you could really miss out if the markets go back up.
So how much money should you keep in cash?
The exact amount to keep in checking and savings will be different for everyone, but it’s the sum of three things:
The money you use to pay your bills. This one’s fairly straightforward — money for everyday living expenses should stay in the bank.
Your emergency fund. Seriously. Keep it in cash. The exact amount you need will depend on your financial situation, but we typically recommend aiming for three to six months’ worth of take-home pay (or up to nine months’ worth, if you’re self-employed).
Any money you’ll need within the next two years. Save for short-term goals (vacation funds, money for next year’s car insurance, etc) in cash, too. If the markets keep going down, one or two years may not be enough time for it to hopefully go back up. Investing is a long-term game, so it’s generally better for timelines longer than two years.
That said, if you’re approaching the last year or two of your long-term investing goal — say, you’ve been investing to put a down payment on a home and want to do it next summer — it’s not so black and white, especially if you’re not sure you’re going to use it that soon. Whether you decide to withdraw it as cash or leave it invested (ideally in a portfolio that gets more conservative as you approach that date, like we do for you at Ellevest) is up to you and your tolerance for risk (and taxes triggered by the withdrawal).
When the economic landscape feels uncertain (like right now), it’s OK to pad your numbers just a little — keep a little extra wiggle room in your checking account, beef up your emergency fund a bit. But the advice is the same, at its core.
So channel your inner Goldilocks when you’re determining how much cash you should keep in the bank — not too hot (much), not too cold (little), but juuuust right. And feel good about the fact that you’re doing right by Future You.