Q: I am 27 years old and have $40,000 in the bank and $180,000 in retirement accounts. Should I be saving more in cash? I have a good income and modest expenses so I'm living within my means, with the only big expense upcoming being a wedding next year.
A: Today's low interest rate environment demands thoughtful cash management, which is why you might want to consider some alternatives to leaving too much money sitting passively in cash.
The good news is that it sounds like you are off to a good start in retirement savings. Still, building a retirement nest egg is a long-term process, so there is still plenty of more work to be done. So, would some of that $40,000 serve you better if invested in long-term assets than sitting in a bank account?
To answer that, consider these four questions:
1. How much do you need in an emergency?
Savings accounts provide immediate access to cash in an emergency, so one factor in determining how much to keep in a savings account is figuring out how much you might need in an emergency. People tend to think of financial emergencies in terms of unexpected expenses, but often the most devastating type of financial emergency is the loss of a job. Having enough cash on hand to cover three to six months worth of essential living expenses is a good way to prepare for this risk.
2. How much do you plan to spend on your wedding?
Some weddings these days could easily eat through your entire $40,000 cash stockpile. Before you determine how much to leave in cash, you need to plan on how much you intend to spend on the wedding. Also, setting a budget in advance may save you from overspending.
3. Will other major expenses follow the wedding?
People often follow marriage with buying a house, or at least moving to a larger apartment. If new housing is in your near future, it may help determine how much to keep on hand in cash.
4. Are you saving for the short or long term?
As you think about the wedding and other possible cash needs, it is not just the amount that is important, but also the timing. For example, in the case of money you need for the wedding next year, even a 6- to 12-month certificate of deposit should earn you more than a savings account, especially if you shop around for the best CD rates. In other words, there is a middle ground between keeping cash in a savings account and committing it to long-term investments.
Savings accounts give you safety and liquidity, but little else these days. The important thing to remember is that earning a low interest rate is not just an opportunity cost. It also means a very real loss in purchasing power terms, to the extent that most savings accounts these days earn less than the rate of inflation. Some attention to cash management can help you minimize those purchasing power losses.
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