How Much Is the Right Amount Of Cash?

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The Hosts:

Kevin Kroskey, CFP®, MBA – About – Contact

Tyler Emrick, CFA®, CFP® – About – Contact

Intro:

Hey, thanks for joining us for another edition of Retire Smarter. This is Walter Storholt, alongside Tyler Emrick, wealth advisor and certified financial planner at True Wealth Design, serving you in northeast Ohio, southwest Florida, and the greater Pittsburgh area. Find us online at truewealthdesign.com. We’re going to be talking about cash on today’s episode, so stay tuned for that. More on it in a moment. But first, Tyler, what’s up in your world?

Tyler Emrick:

Oh, not much, Walt. Doing all right. Hanging in there. We’re starting February, trying to get through winter, and hopefully, we get a break in the weather here pretty soon.

Walter Storholt:

I was telling Tyler that I bought a new house this weekend, and he admitted that he is still unboxing from his house move a couple of months back. So I think now we need a little side competition, Tyler, of who can unbox the last box first. Get there first to the finish line.

Tyler Emrick:

Don’t know if I want to commit to that. You have a hard stop.

Walter Storholt:

I like my chances based on how long it’s taken you.

Tyler Emrick:

Have a hard stop at the end of February, so I can’t commit to that timeframe. I’m waiting for the weather to break, a little sunshine, and a little more activity to get it done.

Walter Storholt:

Are you the style that lives amongst your boxes, or do you find a room to just shut her off and pile everything into there?

Tyler Emrick:

Yeah, a little bit of room and shut her off I think, is probably the best bet. And then eventually getting back to it and going through and sorting through it. But yes…

Walter Storholt:

Well, that’s at least one style. We’re still stuck actually living among the boxes. So I tripped over one when this morning, trying to come into the recording today, and it didn’t break an ankle but made a loud noise nice and early in the morning.

Tyler Emrick:

I’m past that stage. I guess in the basement, there might be a small corner with maybe a box or two in it, but…

Walter Storholt:

Well, let’s get to today’s conversation and dive in because it’s an interesting topic, as the economic markets are maybe shifting a little bit. The headwinds are changing, there’s lots of predictions of which direction things are going to go here in 2023, and it sounds like, just based on conversations with you, it’s got people asking you guys at True Wealth Design, a little bit more frequently and often now, about cash and how much is the right amount to have on hand since things are starting to change a little bit. And this is, I think, a good just sort of general financial and retirement planning question. We get into emergency funds and just wondering how much should you have on the sidelines and are you missing opportunities? All those questions in a normal environment pop up, but now we can view everything through a whole new light as well.

Tyler Emrick:

You look over the last 18 months with just a rapid rise in interest rates, those interest-bearing cash positions, which a little farther back had been giving minimal to no interest, and your checking and saving accounts are definitely now paying higher rates. It seems like every day I run across a new commercial or an ad marketing a new CD, a savings account, really trying to advertise those new higher rates and-

Walter Storholt:

They’re replacing the crypto commercials from 2022 that we saw.

Tyler Emrick:

They are, I could do without the crypto commercials coming back, though, but-

Walter Storholt:

I hear they’re out on the Super Bowl this year. It’s much more heavily alcohol commercials, apparently. So the sign of the times.

Tyler Emrick:

Back to the norm. Back to the norm. We get it. We understand that we haven’t earned interest rates this high for, I was looking back through the data, almost 15 years before, we’ve seen interest rates and checking accounts and savings accounts get to the level that we’re starting to see.

But before we jump the gun and say, “Hey, cash is the new king,” we thought that it would be a good time to give our perspective and a little bit of insight on how we approach that decision on how much cash is the right amount of cash. And when I look back through all of the textbooks for my CFP® and all that stuff, I mean, I think the general rule of thumb is three to six months is the one that we traditionally heard. I don’t know if you’ve heard that one before, Walt, but that’s what we probably run into the most.

Walter Storholt:

Yep, three to six months seems to be the word on the street over the years.

Tyler Emrick:

Three to six months’ worth of spending. As with anything, as we get a little bit more granular into that and peel back the onion a bit, I think it can be very dependent on really your household and family dynamics. If I threw out two situations to you, Walt, like, hey, you’ve got a family of two teachers who have very reliable income, have worked in their jobs for a number of years versus two individuals that are sales professionals at five rental properties. I think it’s pretty clear there which one’s going to need more cash reserves.

It comes back to that variability in income, variability of expenses, and how that works on your family, and that is how we back into that right number. The two teachers with very consistent, reliable income, maybe they only need a few months’ worth of expenses set back in cash. Whereas if you have a lot more expenses going out, a lot more variable income, or maybe, hey, you have some large expenses coming up that you want to certainly prepare for. Those are some of the things or the situations where we might say having a little bit more in cash makes sense.

But at the end of the day, I think it definitely comes back to personal situation and what’s going on in your household. I think the current market environment with these interest rates, as we alluded to, helps trends or people are thinking about, “Okay, hey, how do I take advantage of it, and should I have a little bit more in cash?” I’ve got more than a couple handfuls over the last six months of emails asking, “Hey, should I get into a CD?” And boy, two, three years ago, I don’t think I got any questions about CDs because the rates were so low.

Walter Storholt:

What’s a CD? Who needs that?

Tyler Emrick:

Exactly, but I think the ad and the marketing that I’m seeing the most is like a one-year CD, around 4% right now. And individuals are looking at saying, “Hey, 4% might look pretty good.” But again, as we dive into that situation, when you think about the CD rates and how the yield curve is positioned right now, one thing you got to always be mindful of before you put your money in a CD is, well, what’s that lockup period? Because there’s some risk there.

You look at those rates right now, and a high-interest CD, some of the higher ones, are paying on for a three-month, maybe 4, 4 1/2 %, but you go down and go to a three-year CD that might be paying 4.7. Three months to three years, there’s really not that much difference for locking up your money for a long period of time. So as you look at that lockup period, when we look at the CD rates right now, really, the juice is not worth the squeeze when you look at locking your money up for a long period of time because those interest rates for short term and long term are so comparable.

Walter Storholt:

Makes a lot of sense, yeah.

Tyler Emrick:

So we’ve been looking through and saying, “Well, what are some good alternatives?” And one of the ones that we’ve looked at are just a high-yield savings account. You go and Google high-yield savings account, you’re going to see a whole host of options come up that are FDIC-insured, where these banks are offering pretty sizable rates. I see them in the high threes, close to 4%, which that can be a good option because you’re not looking at and you don’t have any lockup period. So that liquidity is still there. And for some individuals that have kept maybe a little bit more in cash, we’ve looked at RoboCash management services. Have you heard that term before, Walt, I think Robo-advisor-

Walter Storholt:

Is that like Robo-advisor?

Tyler Emrick:

Yep. So automatic, you could think of it as that, but basically, it’s a service that might attach to your current checking account. And what they would do is they would go and shop around the highest FDIC-insured rate that you can get for that upcoming month, and they partner with a whole host of banks, and they look within all those banks, and you can optimize that cash for a month and say, “Hey, within my current checking account, I’ll place it with this bank, have the FDIC insurance and get the highest rate.” And then they would look at it again the next month and the next month, and you’ll be able to shift behind those. And as the interest rates change and different banks offer better rates, you’ll be able to take advantage of that within the program banks that they work with.

Walter Storholt:

Am I actually hearing a financial advisor say something positive about a Robo-advisor?

Tyler Emrick:

I would say positive. A, it’s an option, but yeah, I think it works in some good situations.

Walter Storholt:

I was going to say it might be a first, it might be a first, Tyler.

Tyler Emrick:

You look at the alternative and go into a high-yield savings account, what do you think is the likelihood of you, if you go and open up a new savings account because that’s the one that’s paying the highest rate, do you think two months down the road you’re going to look and go open up a new savings account and transfer your money to the new bank because it’s paying more?

Walter Storholt:

It sounds like a nightmare to try and do all that.

Tyler Emrick:

So those cash management services are doing that for you. They’re going to charge you a fee to do it. So you got to make sure that that fee offsets and is fine in your situation.

Walter Storholt:

So it’s like having an insurance broker who’s going to shop you different rates, and then each year, instead of sticking with one insurance company for a really long period of time and getting those discounts, of loyalty discounts, you say, “Nah, each year I’m fine switching to a new insurance company for the vehicles, whoever’s given me the nice introductory cheaper rate. And then boom, next year we can shop it again if need be.”

Tyler Emrick:

You got it.

Walter Storholt:

Well, that’s different.

Tyler Emrick:

Absolutely. And that’s maintaining that FDIC insurance as well. Some other alternatives that we’ve done as well is you look at treasury bills, for example. You can get into a T-Bill ETF, the 90-day yield on something like that’s just under 5%. So you’re looking at a pretty nice and sizeable interest rate for a position like that, and they’re extremely liquid, and you can get your money in and out very quickly if you needed it. And you also have some risk or some opportunity depending on what interest rates do, to maybe even have some more appreciation as far as price goes in those types of investments as well. So Treasury Bill ETFs, I think, would be another option or alternative to those CD rates that we’re looking at and exploring with some of our families. And I think, all in all, families do a pretty good job of, or at least the families that I’ve talked to, do a great job of really understanding those cash levels and their checking and savings accounts.

But I think what becomes a little bit more difficult is those cash levels in retirement accounts. So ROTHS, IRAs, investing accounts, 401ks, and the like. A number of years ago, I was introduced and met with an individual. He had come in, he had given me a call, and said, “Hey, I’m looking for someone to give me a second opinion on what I’m doing and the advisor that I’m working with.” So he came in, and we met, had a great conversation, went through his situation, and at the time, he really wasn’t ready to make a move. He actually decided not to hire us. He wanted to stay with his current advisor. He had known his current advisor for a number of years. They had a great relationship, very personable. And the way the relationship typically worked was he would go in and meet with the advisor once a year.

They would come in, talk about the portfolio, maybe make some changes. The advisor would recommend a couple sells or buys, and they might do it or they might not. And then they would rinse and repeat and do that again the next year. Obviously, if he had a question, he could always call the advisor. Sometimes make a call and sell out of an investment or whatever the case may be. But that was the relationship that worked with them. I actually got a call from him a few months ago. He wanted to come back in because, boy, it’s been almost four years since our first meeting, and he decided to stay with his first advisor. And I was like, “Yeah, great. Come in.”

Walter Storholt:

And only a few things have happened in that four years.

Tyler Emrick:

That’s right, too many to count. But he’s like, “Hey, I just wanted to check in again. Wanted to get an update on my situation, just talk through a few things.” So I was like, “Sure, come on in.” So we sat down, and we’re chitchatting, talking through everything, and he brought in his statements for me to look at, and I’m going through, and he’s got a handful of accounts. So I’m going through each statement. I’m looking, I’m saying, “All right, hey, Roth, $20,000 in cash. IRA about $30,000 in cash in there. You got about $10,000 in your trading account,” so on and so forth. I mean, I look up, and I’m like, “Hey, you know, had over $100,000 just sitting in cash across your investment and retirement accounts. And he took a step back and was like, “Well, yeah.”

I think he knew it, we had got into the conversation a little bit, and over time he just, “Hey, at the end of 2020, we had a run-up. I made a sell in a position and then just didn’t buy back in. I had some of my dividends that were going to cash. They just didn’t get reinvested.” It was almost by happenstance. When you’re only looking at those portfolios once a year, and you’re maybe making changes or not, sometimes that cash can get, they almost fall through the cracks a little bit Walt, because they’re not looking at it. And if you have five or so, I mean in his case, I think you had over five accounts, it’s very, very easy. And one account, you just look at it and say, “Ah, that’s a small cash position. That’s not too bad.” But then you add them all up, it can be a bigger issue.

And I just did some quick math for him, and I looked back over the last few years, and I was like, “Well, you’ve been averaging almost 10% return per year in your accounts. You got $100,000 in cash. If it’s been sitting there for as long as you tell me it has, you’re giving up almost $10,000 a year in interest.” It’s not a small chunk of change, mainly due to almost inefficiency, let’s call it. Because he wasn’t deliberately just saying, “Hey, I want to leave it in cash because of X, Y, Z.” There was no real plan around it. The cash had, eventually, it just had built up over the years. And when you put that dollar and cents to it, and you look at that, it’s like, wow, that’s a big deal. In the industry, we call that cash drag on a portfolio,

Walter Storholt:

Cash drag.

Tyler Emrick:

Cash drag.

Walter Storholt:

Dragging down the portfolio.

Tyler Emrick:

Dragging down the portfolio returns. So cash costs investors returns in the long run because it’s not invested. In any given year, we can’t time it. We don’t know what’s going to happen in any particular market. I understand that last year we’re coming off of some historically bad performance, both in the stock market and really specifically in the bond market. But still, you start adding up these years. There’s a reason why we come up with diversified portfolios, and we want to stay invested, and we don’t want to try to time the market. And cash is really just paying the risk-free rate. So you’re giving up opportunity costs or investment returns in the long run if you have too much cash in your portfolios. Don’t get me wrong, cash is useful in portfolios for liquidity. It has low transaction costs and stability, but holding that too much really does eat into those long-run returns.

You think about the market environment we’ve experienced over the last few years since I had talked with him. There’s been many ups and downs, but you still look back over his performance, and in aggregate, he’s had some pretty nice performance over those years, and that’s what we’re getting at from that cash drag standpoint.

In the news, over the last few years, there has been a lot of news on one of the major discount brokers in our industry, Charles Schwab. They have a certain amount of cash that had to be required in some of their portfolios and some of the services. And they’ve gotten a lot of pushback from the industry and the SCC and all these different regulators saying, “Hey, is that right? Should they require a certain amount of cash be held in portfolios over the long run?” Because you look at their situation, they might have had some benefits for keeping cash, and they might have made some money off of it, but they weren’t maybe charging fees for the portfolio. So there’s certainly a give and take here, and you got to be a little bit careful. But in aggregate, when we look back on those historical performances and those historical returns, we feel much more comfortable having your money invested and being very deliberate about the amount of money that you’re keeping in cash.

Walter Storholt:

Great discussion so far on all of these different cash considerations. And I never realized, Tyler, that this cash conversation went beyond just really that emergency fund feel to it, but it’s much deeper, as you layer this into talking about retirement and lifestyle and maximizing returns of that cash and different ways to use it and manipulate it to your benefit and lots of different areas of your financial life.

Tyler Emrick:

You got it. You think about a retiree. When you retire, what’s the first thing you got to come up with? Where are you going to get a paycheck from? How are you going to start distributing assets out of your accounts? And that’s another area where I think that the way you set up that distribution strategy plays into that whole cash drag conversation. You take a scenario where, okay, maybe I just do a large distribution from my IRA account at the beginning of the year. I live off that asset and then at the beginning of next year, I do the same thing. Well, what you’re doing is you’re pulling a lot of money out in investments at the beginning of the year, sitting it in cash, and then slowly spending it down. That goes against what we were talking about with that whole cash-drag conversation.

And the approach that we take typically for our families is we really would like to identify those expenses that are recurring on a monthly basis and set up some type of recurring monthly withdrawal out of your retirement account so that way, you can match your spending with the withdrawal. And then, for any big large purchases that you might have come up throughout the year, do those distributions as needed.

So, for example, you might have a family where they are spending $5,000 a month, and they’re doing about $15,000 of gifting per year to their church or charity. So, you take that situation, we might set up a monthly withdrawal out of their IRA of $5,000 a month. They’ve got that, and then at the end of every year, we’ll do a large distribution to take care of their gifting needs for that particular year. And we will use those monthly distributions as times to do some opportunistic rebalancing inside their portfolio.

Because as you think about it, every time you do a withdrawal out of your account, it’s got to come from somewhere. So you got to really look and be deliberate about, okay, which investment do I sell out of? Do I sell out of the stock? Do I sell out of a bond? And what’s going to be most beneficial as we look at that situation? And then too, how much should we keep in cash to meet that next monthly distribution? Should we have three months set aside? Some companies do even longer than three months, but we tend to run our cash reserve levels very tight because we don’t want to have that major impact from the cash drag.

Walter Storholt:

All right, very good. So any other cash elements we should be aware of or angles to consider on today’s episode?

Tyler Emrick:

No, I think those are the big ones for today. I think the big takeaway is just be deliberate about what you’re doing and make sure that you take the time to understand, okay, my cash just isn’t my checking and savings accounts. Yes, we want to optimize that through some of the solutions that we talked about today. Make sure it fits in with your overall portfolio strategy, but don’t forget about some of those other places cash can build up inside your accounts and making sure that you’re utilizing them to your benefit.

Walter Storholt:

The question today is, of course, how much is the right amount of cash? And so if you need some help getting the answer to that question, as always here on the show, it’s going to vary from person to person. So if you need help figuring that piece of the puzzle out as it relates to your financial and retirement plan, reach out to the True Wealth Design team. You can do that a couple of different ways. One is the phone number, 855-TWD-PLAN, 855-TWD PLAN, or maybe the easier way, go to truewealthdesign.com and click on the Are We Right for You button to schedule your 15-minute call with an experienced advisor on the True Wealth Team. Again, that’s truewealthdesign.com, and we’ll put that contact information in the description or show notes section of today’s show as well.

Tyler, thank you so much for your help and the guidance on the show today, and we’ll look forward to catching up with you again soon.

Tyler Emrick:

It’s been great. Talk to you soon.

Walter Storholt:

Very good. That’s Tyler Emrick. I’m Walter Storholt. Thanks for joining us. We’ll see you next time on Retire Smarter.

Disclaimer:

Information provided is for informational purposes only and does not constitute investment, tax, or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fee.