This is a great question and the topic of many conversations we have with clients. While there can certainly be some nuance depending on your particular situation, a good rule of thumb is the equivalent of 3 to 6 months of living expenses. Note the word “expenses”, not wages. For the great majority of situations, apart from single-income families with children, 3 months is likely more appropriate.
Why is this an important part of your financial picture? Keeping more money than what is needed for emergencies in the bank will COST you. The amount of stuff you can buy with $10,000 today is not going to be the same next year. Next year, the same $10,000 will buy less goods and services than it will right now because of inflation. This is true always, but now especially with the historically high inflation we are and have been facing the last couple of years.
Your bank knows this, by the way! They’re not just leaving your money sit until you need it for a rainy day. They are investing their excess deposits by loaning it out and making interest on it. But you probably aren’t earning much more than pennies in your checking or savings account.
This is why it’s important to invest excess cash. If it’s money you won’t need any access to for 5-10 years, you might consider investing in the stock market, which has historically been the best hedge for inflation. But remember, the stock market is a long-term investment. The potential returns are the highest out of all the asset classes, but also the most variable over short amounts of time. This variability goes down the longer you stay invested.
See what I mean below. These wheels show different holding periods of the S&P 500 and your probability of having a positive return over each one:
Now, if you might need the funds for a big purchase, vacation, etc within 5 years, you need to invest it somewhere safer in an investment with a fixed return. Right now, this could look like short-term CD’s, Treasury Bills, or a money market fund with a good interest rate. Shorter term fixed investments are the best choice when interest rates are on the rise*.
*Note: The fed cut interest rates this month in a historically unprecedented move so close to the election, which we believe was likely purely political. Our common sense as consumers is enough to tell us that inflation isn’t under control yet. But so does the fact that the government increased the money supply by nearly 40% during Covid, which causes inevitable sticky inflation (see below):
And this is before even mentioning that the inflation calculation the government reports to us can be misleading and manipulated – more on that another time. But ANYWAYS, we expect that rates will need to be raised again after the election.
Bottom-line: It's super important that your cash is being put to work for you! Once you have 3 months of expenses saved up - IT'S TIME TO GET INVESTING!
If you're not sure what might be appropriate for your situation, we can help. Give us a call or email us at info@bobbennie to get started.