As important as it is to have liquid cash as it gives us the ability to cater to our needs and indulge without much friction, holding onto too much has its issues as well. Sometimes, you may also feel a strong urge to do
something about your idle cash but yet feel unsafe to put more into investment.

In this article, we will look into how you can determine the amount of cash you should keep and how to convince yourself to make better use of your idle cash.

How much cash to keep?

Inflation erodes the value of our money. With this concept alone, the best strategy is to hold on to as little cash as possible and invest the rest. To some, having most of your net worth invested can be scary. Here’s why it might be good to understand how much cash you need to keep to feel secure. After all, if you don’t feel at ease with the amount you’ve invested, you’ll tend to make rash decisions with your investment. That usually doesn’t end well. Here’s the formula that we personally use to help determine how much cash to keep.

Idle Cash to keep (AKA have in your bank)= Emergency Fund + Cash needed for a short-term goal.

Emergency Fund

An emergency fund is a sum of money you set aside to cover any financial surprises that life throws your way. Depending on your circumstances, the amount you set aside can differ. Typically, you may peg this amount to either their expenses or income. For example, if you earn $3,000/month and want 6 months of buffer, your emergency fund amount would be $18,000

Why peg against income/expenses? The reason why people like using a multiple of their expense/income is to hedge against the potential job loss. It’s almost like saying, “If I lose my job, I can afford xx months of no income before touching my investment”. So the xx months can be how confident you are with your ability to find a job.

Cash needed for a short-term goal

If you’re working towards any short-term goal, it wouldn’t be recommended to raise it entirely through investment. Especially, when the goal you’re planning for is non-negotiable. For example, if you’re saving up for a BTO renovation, the timeline is definite, you’ll have to spend that amount when the time comes. For such cases, it would not be ideal to park the money in volatile investments.

How short is short-term?

The next question to tackle is “how long is a short-term goal?”. This would depend on your risk appetite, but we will share some information that can help you in the decision process.

In our opinion, there are two main reasons why you shouldn’t invest your the amount set aside for your short-term goal.

1. Emotional toll

If your goal is definite, i.e. the amount and when it is needed is fixed, it can be stressful to watch your investment fluctuate. Take for example you need $100,000 in a year’s time and you invest that sum. A 10% drop would mean that you’ll need to raise the $10,000 from somewhere else. Because you aren’t able to afford not having that $100,000, you will find yourself constantly checking in on the investment value. When it drops below your threshold of risk, your emotion might take control of you and you will sell on panic.

On the other hand, if you don’t need the money anytime soon, you will have enough time to find other ways to finance it. For example, if you invest $100,000 for a goal you’ll need it in 8 years’ time. If the investment drops 50% in the 2nd year, you’re less likely to panic, after all, you still have 6 years to find ways to raise the $50,000. In fact, if you’ve done your investment correctly, your investment might recover in due time.

2. Unforeseeable market occurrence

You may have done a good job at investing, but there may potentially be a market crash. Just in the past 3 years alone, we’ve seen how the pandemic and the Russian-Ukraine war affected the market. The impact on the market from these events is hard to avoid. If such events were to happen when you invested your savings needed for a short-term goal, you’ll have no choice but to either delay it or find other ways to finance it.

If you can’t avoid it, what can you do?

1. For such cases, we can only look back at history and statistics to help us to determine the best course of action. To put it simply, when the stock market crash by 20% consecutively, it is known as a bear market. Historically, since WW2, a bear market takes place every 5 years, last about 10 months and it takes an average of around 19 months to return back to its all-time all. With this, we know that the average time to survive a bear market is around 29 months, that’s about 2.5 years.

2. The word “average” should be taken into consideration, the stats above should just be a reference point for you to decide your risk profile. So on average, if your short-term goal is more than 2.5 years, then you would be able to tide through a bear market and get back your money needed for investment should a bear market happen. But in a not-so-average bear market, then you might have some issues. Make use of this information and ask yourself, what’s the risk I’m willing to take for this goal?

How much to invest?

If you followed the formula above,

Ideal Cash in bank = Emergency fund + amount needed for short-term goal

you would have guessed what’s the formula to understand how much to invest. The remaining cash you have after setting aside your ideal cash in the bank should be invested. Deciding how to deploy this stash would heavily depend on your risk appetite, interest to learn investing, and time.

If you followed this formula, you will realise that you will have more money invested than cash in hand over time. It may seem scary for some, but if you think about it, the cash you hold is definitely losing its value. In a healthy economy, inflation is normal. In fact, some economy aims to keep inflation at 2%. In Singapore, MAS doesn’t have an explicit target but would aim to keep inflation under 2%. What this means is if you simply hold too much cash, the whole economy is working toward devaluating your money.

If you would like to hear from a professional or some help to kick start your investing, you may check out our list of services here.

Conclusion

It may feel good to have a stash of money sitting in the bank, it can give you a sense of security. But sometimes, it can be a false sense of security. Although it would be ideal to have your money invested, each of us has a very different relationship with money and risk appetite. At the end of the day, it would definitely be beneficial to improve your financial literacy and develop a plan of your own.