While there is no hard-and-fast rule dictating what percentage of your portfolio should be in cash, there are some guidelines you can use to make the right decision. The appropriate amount of your net worth that should be in cash depends on a number of factors, including the stability of your job, the visibility of your earnings and how many years you plan to work until you retire.
The stability of your job is an important factor when determining how much of your net worth should be in cash. If your job is stable and the company you work for is in excellent financial shape, you may not need more than the standard, three- to six-months' worth of living expenses in an emergency fund. But if the company you work for is in trouble and you feel layoffs are right around the corner, beefing up your cash position is a smart move. Keeping a higher percentage of your net worth in cash is also wise if your earnings are erratic and hard to predict. If you work as a salesperson or an independent contractor, you can go from making excellent money to next to nothing in a matter of months. Keeping a high cash percentage can see you through the lean times.
Years to Retirement
If you just joined the workforce and have many decades to go before retirement, keeping most, or all of your net worth in stocks and stock mutual funds is a good way to build long-term wealth for the future. But if you are getting ready to retire, keeping so much in the stock market can be very risky. As you get closer to retirement, it makes sense to bolster your cash position and start shifting to an asset mix that can give you the income you need. One strategy is to keep enough in cash to cover five- to seven-years' worth of living expenses, while leaving the rest invested in a mix of stocks and bonds. That gives your portfolio the stability you need entering retirement, while allowing the rest of your funds to grow.
When certificates of deposit, money market funds and other cash-equivalent investments are paying high interest rates, it makes sense to shift more of your net worth to these guaranteed but high-yielding investments. But when interest rates fall, the attractiveness of those investments diminishes greatly. When interest rates are less than 2 or 3 percent, the money you earn may not even keep up with inflation. Interest rates are not the only determinant when assessing your cash position, but they do have an important role to play.
If you have money coming in from guaranteed sources, like a monthly pension or Social Security, you may not need to keep as much of your net worth in cash. This is especially true if your guaranteed sources of income are enough to cover most or all of your monthly living expenses. If you lack these guaranteed sources of income, you may need to increase your cash percentage to pay the bills and maintain your lifestyle.