Q: I’d like to know how much of my investments should be in cash, that is, money markets or bank accounts. In a large portfolio, 10% might be a good value, but if a portfolio is smaller, maybe I should take an approach of keeping enough cash to cover 2- 4 years of living expenses. Do you have any comments/feedback on how to decide how much to keep in cash? This will be a very valuable input to me.
A. There are many planners advocating that you put up to three years in cash right now, then start depleting the cash reserve as the market goes down, and replenish it when the market is higher. No one knows what the future will hold, so you can't tell what will be best. However, if you had one year of cash and hold short maturity bonds and CDs, all laddered, you would probably do better than 2-4 years of cash. CDs are great from FDIC considerations because the government will insure up to $100,000 of bank CDs in each account.
The main thing is to be able to draw down investments as you need to. That means you need liquidity, hence the need for money markets or bank accounts. So I’d say that you should have whichever has the larger cash requirement: (1) 10% of your retirement portfolio in cash accounts or (2) one year of cash plus bonds or CDs maturing on a regular basis for the next couple of years. Of course if you have significant deferred-tax accounts and are over 59 1/2, you’ll have the necessary liquidity, but the same problem as in a taxable account if you have to sell stock or bond funds in a depressed market. So I’d use the same guidelines.