What is the appropriate amount of cash to keep on hand in a savings account?  It’s a question we are asked frequently and one that is important for everyone.  Part of the reason that the question is so prevalent is because there is no perfect solution.  Everyone’s situation is unique and the right amount of cash reserve varies with each situation.  When we refer to cash, we are including bank deposits, savings accounts, money market funds and cash on hand.  Cash provides liquidity, peace of mind and carries almost no risk but, in today’s low interest rate environment, the return is miniscule.

There are a few different aspects of cash and cash equivalents that are important to consider.  It is important to have a cash reserve that will not only cover everyday living expenses but also provide a cushion for emergency or unforeseen events (loss of a job, medical emergency, major home repair, etc.).  Although there is no precise rule of thumb, most sources would recommend that you have somewhere between 3 and 12 months of living expenses in cash savings.  In order to be comfortable with the amount of cash savings you have, it is important to ask yourself the following questions:

• How stable is my current employment and income?
• How easily can I replace my income?
• Do I have additional sources of income (pension, social security, trust, etc.)?
• Do I have individuals that are dependent on me?
• How well insured am I (health, property & causality, etc.)?
• Do I have a large amount of debt?
• How much do I have saved in other investment vehicles and how liquid are they, especially in times of economic stress?

Factors that would dictate a lower need for ready cash include minimal debt, easy access to invested assets, quality insurance, and other sources of income such as a pension.  On the other hand, a combination of factors such as an inconsistent income stream (self-employed), large families that are dependent on one bread winner, high student loan debt, little to no insurance and a large percentage of investments tied up in tax-deferred accounts that aren’t accessible without penalty would generally mean that a larger cash reserve (closer to that 12 month expense number) would be needed.

As you mull this question over as it relates to your own situation, don’t make the mistake of keeping your cash reserve too high either.  There is an opportunity cost of holding cash as well as exposing your situation to the effects of inflation eating away at your purchasing power over time.    Although an argument can be made that the safety of cash is better than a potential loss in the stock market, holding excessive cash over long periods of time will be detrimental to your financial health.  Letting the market and market volatility dictate the size of a cash reserve can be a losing battle.  That being said, the emotional aspect of this cash reserve question is something that holds weight.  Everyone is different and for some, holding a higher cash reserve means sleeping better at night.  Although there is no magic number that needs to be saved, by better understanding the factors at play you can find a cash savings amount that works for your situation.