Personal choice - old habits for keeping money easily available, more for peace of mind than anything else. Not all that smart. The reason I mentioned the it is that I think most people keep their bank account pretty lean and wouldn’t have that buffer.
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Keeping a healthy amount of money in cash has alway been part of our savings strategy (though what we consider a “healthy amount” has changed raw numbers wise over the years).
Our plan is to have 2-3 years expenses in cash/cash equivalents at retirement age - so that we have some flexibility as to when we draw down monies from tax-advantaged and taxable accounts, as well as taking advantage of Roth conversion if it makes sense at the time.
Every person is going to measure their risk tolerance and cash flow differently. I remind myself of that when I want to side eye people who manage their money/accounts differently than I would. I would hate the idea of having to ‘go to the well’ when markets are going a bit crazy - having a cash cushion helps me remain dispassionate in regards to the rest of our portfolio. Other people are much more comfortable with another kind of plan. 
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Is that flexibility needed simply to keep your taxable income below a given threshold (eg higher Medicare payments or higher income tax rates) or because you keep all of your retirement assets invested in the market? Would you keep any of your retirement account (eg money needed in the next year or two) in cash?
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We are quite a bit away from ‘retirement age’ so our plan has less to do with specific Medicare payment rates (who knows what those will look like in approximately 20 years) or income rates (we do our best reduce our taxable income now, but again who knows what that will look like when we retire).
It is more to make sure that when market corrections/craziness happens (and it happens regularly) - we aren’t thinking about having to liquidate during a down turn. The cash cushion we keep is so that we can continue following our IPS no matter what the market conditions look like.
Cash is part of our portfolio. I know some worry about the drag cash can add to a portfolio and prefer to see all their money ‘working’. Personally, this confuses me as when our portfolio was smaller, the amount of money we had in cash was substantially smaller as well, so the ‘drag’ was basically meaningless. And as our portfolio has gotten larger and our cash reserves have increased as well, the drag remains pretty meaningless in the overall size of the portfolio.
I’m much more concerned about of our consumption choices (house, cars, college costs, etc), portfolio expense ratios and savings/contribution rate than I am worried about the potential ‘drag’ our relatively small cash position (to the overall portfolio) will have. We’ve gone through 3 fairly large market corrections at this point (2001, 2007-8, and 2020) without changing our overall strategy and feeling fairly comfortable during economic downturns. A big part of our comfort was knowing we had our cash cushion.
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Agree with beebee-- and also, much of the cash discussion needs to take into account other family members (elders, siblings, etc.) for whom you have some financial responsibility.
I’ve got friends who have been in a blind panic trying to assemble the dollars needed to pay first month/last month at an Assisted Living facility (not cheap if you are in a high cost labor market) when a parent was being released from rehab but couldn’t go back to their own home. And I know people who have needed to bail out other family members so as not to be evicted, their junker car which they rely on for work is undriveable, etc. I’d rather know I can be the backstop without having to sell in a down market than squeeze every penny out of an asset.
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But my question was if it makes sense to keep that cash cushion in taxable accounts or if you could leave that extra money in your retirement account (where it could still sit in a money market investment if you are worried about stock market fluctuations)?
For example I’ve seen articles saying keep taxable bonds in a retirement account because they would be taxable as ordinary income if held outside your retirement account, whereas stocks are taxable at lower capital gains rates.
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Sorry I misunderstood your question. I don’t keep the cash cushion in tax advantaged space.
Our cash cushion is spread out over a few of instruments: HYSAs, CD ladder, I-Bonds, and money market fund at our brokerage. So, placed in our taxable accounts.
Where one keeps bonds v. stocks is something slightly different, to the best of my understanding. Stocks are tax efficient so if you have both tax advantaged and taxable accounts - it is often recommended that you keep your stocks in taxable, and if possible have your bonds in Roth space or HSA space (which would be tax free on qualified withdrawals). It’s also nice to keep your bonds in tax advantaged space so as not to incur taxes if/when you are switching allocation. You can exchange instruments within your tax advantaged space without paying taxes on the change. Keeping stocks in your taxable accounts also means being able to tax lost harvest.
All that being said, I’m not concerned about the tax implications of my cash cushion (the earnings on it have ranged from 2% - just over 9%). Ease of access and liquidity are my main targets with cash.
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Other than Money Market (which you could within the IRA portfolio), or high-yield savings, any suggestions where else?
Short term bonds are another option.
It obviously makes no sense to keep cash reserves in a retirement account before you turn 60 and can withdraw them. After that you have more options, and I would expect deciding how to spend down your retirement vs non-retirement accounts would be one part of your tax/RMD/Medicare planning.
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Appreciated! Mainly wanted to check if I overlooked anything. I do have some S/T fixed income funds, but in recent years, they too have seen long stretches of market pressure.
Like @beebee3, I have been keeping two years “liquid” (money market) in IRA/401k in the years approaching retirement age, or in the 529 two years before tuition due, to avoid having to liquidate at inopportune times.
I tend to “greed” invest in the early years; with that I’m perfectly comfortable to “time-blend” that with a few years of cash-equivalent close to “liquidation” time.
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Love that quote. 
For me, I thought it was really important to spend the time to figure out what my real risk tolerance was. And to also accept that portfolio perfection is unrealistic. I don’t need the perfect portfolio, I need the portfolio that will give us the best shot at success for our goals.
I know some people can be 100% equities for years or decades. That shows some serious risk tolerance. That isn’t me. We are usually between 70-85% equities (depending on the market) and 10-25% bonds. Around 3-5% of our portfolio is in cash equivalents depending on the time of year*.
Knowing we don’t have to perfectly optimize our allocation was what helped us figure out what we personally valued and wanted to focus on. That is how we decided it was more important to keep track of the big purchases, and the expense ratios within our portfolios rather than worry about the drag our cash cushion might engender. If that means we pay taxes on the interest the cash generates, so be it. We’ve offset those interest gains through our tax lost harvesting.
*We are closer to 5% cash at the end of each year as we front load our investing each year. So, beginning of January - we fully fund IRAs, HSA, 529, etc, as well as put our new targeted savings contribution plans into effect (we like to try to increase savings by about 1-2% a year and have found front loading helps us gather momentum at the beginning of each year).
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It’s relevant to specify how the “cash” is invested/stored. With the fed rate expected to continue at >5% for quite some time, some types of short-term can have decent risk adjusted returns compared to the overall market, much higher than most of the 2010s when fed rate was `0%. For example, the short-term fixed income portion of my portfolio currently split is roughly as follows.
- 12% of portfolio – Special opportunities, such as bank bonuses, earning average of 13% APY after bonus
- 7% of portfolio – T-bills earning average of ~5.6% APY + state/local tax exempt
exempt - 2.5% of portfolio – Money markets earning average of ~5.4% APY + partially tax exempt
- 0.2% of portfolio – Cash earning <5% (sometimes 0%), such as Paypal balance
The average short term return of components above is 9-10%, which is a far better average risk adjusted return than a stock market index. Some of these categories are not particularly liquid. For example, if I need to withdraw from the bank bonus early, I get no bonus, dramatically hurting return. I include the other categories for better liquidity. In a pinch, I could sell the t-bills on secondary market, but still not as liquid as the money market, which functions more like cash. I transfer from the money market as needed to other accounts, and keep the portion of cash earning little APY as low as possible.
Optimal bond % depends on risk tolerance, time horizon, and other opportunity cost. For example, prior to COVID, the fed rate was ~0% and 10-year bond rate was ~0.5%. This seemed like a bad time to invest in bonds. Bonds paid little yield, and bond price was unlikely to increase much unless the fed rate decreases further, going negative, which has never happened before. Opportunity cost was quite high. If the stock market was too high risk level, bonds are not the only option to reduce variance of portfolio. In contrast, today, the fed rate and 10-year bonds both are ~5%. Bonds are looking more appealing again with lower opportunity cost, and as such, I have increased my investment.
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Here’s an article from the WSJ on budgeting.
@beebee3, for quite a while, prior to getting a financial planner, I think I was all or almost all in equities and alternatives (real estate, small investments in hedge funds, private equity) that are or were supposed to be less correlated with the market. When I brought on an FA, I added more fixed income mostly individual bonds but also a private credit investment. I think we ought be rolling into more fixed income as we feel we are closer to an interest rate peak. I have not been big on bond funds but more on specific bonds.
Just read this article on using Closed End Funds for getting fixed income investments at a discount. I don’t think I’ve ever purchased closed ends funds, so time to investigate.
We’ve had opportunities to invest in hedge fund offerings and private equity fundings but have for the most part declined those offers. While the rewards can be astronomical, the risk wasn’t worth it to me. I don’t have any faith that any PEs or HFs can make active choices well over the long run and I don’t trust myself to pick the rare ones who have been able to (in the past).
I’m not looking to beat the market, I’m doing my best to match average market returns spending as little as possible in expenses. John Bogle had it right, imo. The nice thing about following his philosophy is that I don’t need to worry about whether we are close to an interest rate peak or the bottom of the market in order to execute my IPS. We’ve done our best to maximize our income and savings, and aren’t looking for anything more than what we consider ‘enough’.
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I’m so glad this thread just got bumped as I was just thinking about it.
Dh and I were up late talking and talking about our budget/money. That never happened constructively in the past so, for now, I will drop the @#$^&$ adjective in front of YNAB and just say that this whole process has been only a little painful but has yielded great results. I asked him whether he sees us doing this into perpetuity, and he says yes. Go for it, dude! I am so relieved that he has latched onto this app and is so much more involved with our finances. Now, if I get hit by a bus tomorrow, I feel like he’ll know what to do. 
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Good points. And really, any method that helps you get a handle on where the money goes is helpful.
In my mind, the main thing is to have a way to “catch it all” in tracking, even if by big categories (for me it’s Visa + check + autopays + cash; annual review of Visa reports). Even better would be the app, with all the details.
What did NOT work very well for us was the advise we got from some financial planners / classes…. to list items (mortgage, utilities, etc) / amounts and total them. It is just too easy to miss the normal but non-essential spending.
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@beebee3, I don’t want to sidetrack the discussion from budgets as I was just responding to one of your posts about 100 % equity allocations. My interest in alternatives is not to outperform the market but to find investments that are not or are less correlated with the market.
Gen Zers discover that budgeting by hand works better than using an app.
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DS2 uses a spreadsheet. I love how much he loves it.
Dh and I are on month three of YNAB, but we haven’t linked our cards or bank info to it. So I feel like we are doing a hybrid approach – a glorified, fancy spreadsheet. Dh really has come a long way. He’s fully engaged in the process, and I am so grateful/relieved.
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Sounds like you’ve found an effective solution for you/DH. Good job.
The rest of the info below includes some repeat of past posts… added in case there are new readers here thinking about the topic as they start planning for future retirement……
We also have a hybrid way to deal with spend tracking. For us it is mostly just monthly tracking (“outflow” total = checks + cash + autopays + Visa; we don’t really budget at a detailed level.). Two years ago I created a spreadsheet (actually Google docs sheet) that looks a bit like the picture in the article to summarize the “regular” monthly bills, with only occasional update as costs creep up. Also we do annual review of the Visa category breakdown, which has some overlap with the spreadsheet.
It has been ever so helpful to understand our spending outflow average because our low-ish pensions need supplementing from other investments and IRA. Our financial advisor checks with us at each visit about whether our monthly “Schwab paycheck” amount auto-transferred to checking account is still adequate. So far we’ve had 3 years holding steady with our initial estimate, based on a 8+ years of simplistic tracking.
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