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How Much Cash Do You Really Need?

The right level of cash varies by individual, life stage, access to other sources of liquidity and other factors

Christine Benz 09.05.2017

Getting financially fit--and staying that way--isn't something you can knock off on a Saturday morning. Rather, like any worthwhile project, it's a goal that's best accomplished as a series of smaller steps. Unexpected expenses can crop up no matter your life stage, making it essential to hold liquid reserves--apart from your long-term retirement assets--to defray them. On the docket for May: right-sizing your cash cushion.

But how much cash is enough? That's more complicated than it sounds. While the financial-planning textbooks suggest that people stash three to six months worth of living expenses in true cash instruments, the right amount of cash varies by individual; life stage, career type, and access to other sources of liquidity, among other factors, all play roles.As you assess your cash holdings and determine the appropriate allocation, here are 4 questions to ask.

Question 1: What is your life stage?

The key swing factor in determining your cash allocation is whether you're still working or retired. If you're still working, the main role of your cash cushion is to tide you through job loss. Secondarily, you'll want to hold cash so that unanticipated expenses don't force you to raid your long-term assets--or turn to unattractive forms of financing like credit cards--to meet your living expenses. It's reasonable to use three to six months worth of living expenses as a starting point when setting your cash allocation. You can then refine that number based on your estimation of how long it would take you to replace your job and so on.

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About Author

Christine Benz  Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

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