How Much Cash?

Watch any media coverage of business right now and you can't help but notice that "cash is king"!

Okay, there's nothing new in that mantra. It is always wise as a family or as an individual to have access to emergency cash. But, how much cash is enough? And, does that mean having cash in the mattress? What's safe?

The typical adage about cash is to have somewhere between 3 and 6 months worth of cash on hand ... meaning accessible. But, you really need to look at your monthly bills and the stability of your job (or your spouse's job) in making the right decision. And in fact, I think the job situation is an important new variable in determining the right amount of cash.

First, assess your job stability (and the stability of your spouse's job). Have you had a series of favorable job reviews? Is the company profitable? Is your job necessary where you work? Have there been a spate of layoffs or other downsizing moves in your company and/or at your competitors? Is your firm a market leader or a follower? And definitely consider your tenure with the firm vis-a-vis the tenure of your co-workers.

For example, I work at a financial institution where my compliance work is required by regulation and I am among a handful in the company who perform this task. It's not to say that I can't be replaced but eliminating the area is out of the question. However, my spouse is self-employed and he has laid off most of his staff. My job is much more stable than his job.

Next, assess your monthly outlays. List your required payments ... mortgage/rent, car payments, installment loans, and credit cards. List your discretionary outlays - Starbucks, lunches out, dinners out, theater tickets, vacations, etc. Continue to make every required payment and pay off all of your credit card balances each month. Then take a look at where you would cut back if you or your spouse were to lose a job. What would your monthly outlays look like in the "scaled down" version?

Next, assess the job market in your area (or region if you are flexible to relocate). How long might it take you/your spouse to find a new job? Three months, 6 months, a year? And be critical. Consider your age, your skill set, your desire to stay in the same industry if you were laid off. What benefits would you get from your employer? Severance? Vacation days paid? What about the carrying cost of your health insurance and other benefits if you/your spouse lost a job? COBRA? What about costs for a job search? These are your "unemployment costs".

Take your monthly outlays in the "scaled down" version and add your new, "unemployment costs" and then map out a plan for the number of months you truly believe to be the length of your unemployed status. Now inflate it maybe 5%-10%. That's the cash you need. And you need to revise this analysis at least every 18 months or whenever you make a large purchase.

And by "cash you need", I do not truly mean you need to have it in 100 dollar bills strapped and hidden in your mattress. This level of cash should be in what is known as "cash equivalents". A cash equivalent is an account or an account type that can be easily turned into ready "cash" or a ready balance in your checking account when you need it. Forms of cash include savings accounts, checking accounts, CDs, and money market accounts. It might also be money available on a home equity line of credit. Do not include cash advances - those will cost you a fortune in interest - and do not include balances in your IRA or 401K. The tax impact of pulling the money out is onerous and can put you seriously behind in meeting your retirement goals. Further, you can only set aside so much in an IRA or 401K annually so "catching it back up" is difficult.

A typical savings or checking account is going to earn you a very minimal level of interest in the current rate environment. But, liquidity is a component of risk. There is always a trade-off between taking more risk, including a lack of access to your funds, and getting a higher return versus having ready access to your money but earning a lower rate of return.

A bank or credit union is a good place for your ready-access cash. Credit unions in particular typically offer a better rate of interest on savings accounts (what they call "share accounts") because they are exempt from corporate and most state taxes so they have more money to pay you, their member. Another option is a CD. CDs can be "laddered". In other words, you can set up a series of CDs to mature at various times during the year - one 3 months out, one 6 months out, one 9 months out, etc. The longer you go in term, the higher the rate of interest. Also look for odd-ball terms like 5 months or 8 months. Sometimes those rates are higher than 6 or 9 month terms. But be careful. You can lose all of your earnings if you terminate your CD before the end of its term.

Institutions like banks and credit unions are safe for your money assuming you do not have over the $250,000 insured limit. This limit is established across the sum of the different accounts in your name. Another limit is set for your spouse and another limit is set for any joint accounts. That also means institutions like GMAC Bank, desperate for money and paying high rates, are perfectly safe as long as you see that FDIC or NCUA insured disclosure. Internet banks like INGDirect are also safe for the same reason. Without the overhead of a physical branch, sometimes internet banks pay a premium for deposits too.

But what if you aren't at this "cash" goal?

There are a number of measures you can take in managing your money today to meet your cash goals. Forced savings is one way. There are a lot of banks and credit unions that will set up an automated withdrawal from your account to force savings. You can also work with your employer to split your payroll into multiple accounts, including a savings account. If you are disciplined enough to make the cuts in your discretionary spending, do so. One or two fewer lattes per week will add $5-$6 to your savings and $25 per month.

And of course you can sell the baseball cards in the attic and make millions ... not.

Having ready cash is a great safety net in this economy and will help you sleep soundly at night. It is an important financial goal to meet right now.