What’s the Right Amount of Cash Early in Retirement?

One often misunderstood concept early in retirement is what level of cash you should be holding. Hold too much, and you risk these dollars being unable to keep pace with rising costs. Hold too little, and when the inevitable recession arrives, you may be tempted to sell your investments. Then there’s the challenge of refilling cash when you are no longer earning an income. So, what’s the right amount of cash to hold and how might one refill reserves early in retirement? 

The answer depends on your definition of retirement. Are you working full- or part-time or phasing out slowly from your primary career? How much income is your spouse generating and what’s their ideal timeline for retirement? Are you taking a step back to catch your breath with no formal plans to work or are you entering a second career? 

These are a few questions future retirees should be asking themselves before it’s necessary. Ideally, you have years to think about what you want before a decision must be made. Sometimes life is messy, and you need to decide before you’re ready. What you want (or need) will influence spending and cash reserves.

One reason retirees start Social Security early with reduced benefits is necessity. More income and added liquidity can be easily solved by starting sooner. The fear of benefits not being paid at all (FOMO) also contributes to more retirees choosing an early beginning date.

In the absence of a financial plan, investors often make short-term decisions with their long-term wealth. This rarely ends well. Here’s a better approach.

Cash reserves should be held separately from investments in plain boring accounts. Attempting to squeeze yield from your cash is a popular approach until you recognize more income and taxes on that growth. Your investments should serve the purpose of growth and hedging rising costs for spending, not your cash.

Segmenting your cash into several accounts and providing a specific job description to each is key. There’s likely a long-standing emergency fund, in addition there should be a travel & fun account and perhaps a big-ticket account.

Each of these accounts should be funded to a proper level before retirement begins. If not, when liquidating investments for spending, you’ll want to redirect some cash to top off reserves. For most retirees, their emergency cash hasn’t been used in years and may benefit from being right-sized and repurposed.   

Transferring excess cash from emergency to travel & fun and big ticket can be helpful to set up spending. Investors should be managing these three accounts locally, ideally at one institution/bank. This supports better communication between couples with transparency and knowing where the cash is and the purpose it serves.

When you have a travel & fun account, you’re more likely to spend your money with a smile. The big-ticket account enables you to spend on capital improvements or perhaps a new car when the timing is right. Chances are the car you retire with won’t be the one you’ll be driving in fifteen years.

Segmenting your cash ensures retirees spend their money with more confidence and less worry. Having all your cash arrive in a single account each month to spend can be overwhelming and lead to anxiousness. 

Where does the cash come from to support spending and refilling reserves? Your investments, but not directly from your investments. Establishing a money market account at the same firm where your investments live is essential. This allows you to sell investments and direct the proceeds to your money market account.

This money market should hold twelve months +/- of essential and fun expenses before it’s necessary. Why? Every couple of years company values will shrink with no explanation given. It’s nice to hold cash before this happens so you may hopefully avoid liquidating in a down market.

Your money market account acts like a reservoir with direct links to your local cash reserve accounts and checking account for spending. Automation allows ACH instructions to flow money from your reservoir to local accounts. Spending down local cash and then refilling from your reservoir. When your reservoir is drying up, it’s time to sell more investments so the cycle of spending and managing cash reserves may continue.

What I’ve described above is what we call financial plumbing. Moving the right dollars to the right account for spending and savings. Plumbing systems are prone to leaks. To avoid a leaky financial plumbing system, it’s best to revisit cashflows annually.  

Understand that the first year of retirement will look different than the second year. Life is dynamic and your spending habits and cash will need to adjust to the changes in your lifestyle. Reflecting on your financial plan annually, with the guidance of a planner, allows you to make the most of what you have.   

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