How much cash you should have in the bank, according to CFP

Having more cash in the
bank isn’t how you build wealth.
Andrew Boyers/Reuters

• Cash in the
  bank is a good thing — up to a certain point.
• Banks insure
  only up to $250,000 in an account, so if you have more than
  that, your money is at risk.
• If you have too much in a low-interest bank
  account, your money isn’t working for you. You can get much
  higher returns if you invest instead.
• You need only a certain amount of cash readily
  available in a savings or checking account: between three and
  12 months’ worth of
  income for emergency expenses, and a cash cushion to cover
  irregular one-time expenses.
• You can also have enough for your short to mid-term
  goals (like a vacation).

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Want to hear some scary financial statistics?

Seventy-eight percent of American workers today
say they live paycheck to paycheck.

Only 39% of Americans
feel they could cover a $1,000 emergency if something
happened to them tomorrow.

These numbers indicate that most people probably worry about
whether there’s enough money in their bank account just to get
through the week until they can cash their next check.

If you’re not part of that group, that’s a good thing — but that
may mean you’re facing a different kind of problem on the other
end of the spectrum.

Other studies and polls have shown that it might not be 20- and
30-somethings who are facing these financial challenges. Surveys
show that
millennials actually save more than Gen X and baby boomers,
and could be on track to retire with more wealth than their
parents had.

But can you have too much of a good thing when it comes to money?
That’s debatable — but specifically, when it comes to cash, the
answer is yes.

Do you have too much cash in your bank account?

There is such a thing as too much cash in your bank
account. Stashing money away in savings accounts at your local
bank or credit union can prove problematic for several reasons.

Problem 1: Your money is pretty safe in an
FDIC-insured bank account… up to a point. However, if you have
more than $250,000 in any one account (or in multiple accounts
under one registration type) at a particular bank, you are
putting your money at risk.

While I don’t expect the US to go economically belly up anytime
soon, the fact is that FDIC insurance only guarantees that sums
up to $250,000 are protected. Anything over that, and you could
lose your money if something happens to your bank.

Problem 2: If you have too much cash in your
bank account, you’re making it harder to reach your financial
goals bbecause your cash isn’t working for you. It can’t earn the
same kind of return that is possible if you invest it wisely
according to a strategic plan that aligns with your needs,
opportunities, and desired outcomes.

Having a cash cushion and emergency fund are key components of a
sound financial plan. But if you keep too large a percentage of
your assets in a low-interest savings account, you’re fighting an
uphill battle to build the wealth you need to create the life you
want.

Problem 3: You might think your money is

safer in a bank than in the market, but you may actually be
losing purchasing power because you’re not keeping up with
inflation. This is closely related to problem 1.

Although interest rates rise and fall over time, the rates can
often be very small. And this means that inflation,
which has averaged about 3% over time, eats away at the money
the longer it sits in the account, reducing your ability to
purchase everyday goods and services.

Saving money in cash leaves you exposed to this erosive
power

You might believe it’s better to wait until you feel good about
how the market is performing before jumping into it and
investing. In the meantime, you’ll just keep your cash in
savings.

But market timing is a dangerous game to play (and heaps of data
show investors who try it fail; it’s about time in the market,
not timing the market).

More importantly, you might not be avoiding risk at all. Too much
cash in your bank account is also a real risk because of
inflation, or the increasing costs of the things you want to buy
in your life.

Rafael Marchante/Reuters

Although you may not physically see your account balance drop,
over time that cash will lose value — to the point where it will
be worth less in 30 years than it’s worth today, making it that
much harder to pay for life’s expenses.

All investments carry risk. But failing to invest at all carries
risk, too.

The solution? Determine how much risk is appropriate for you to
take on in order to meet your financial goals. And then
understand that there is such a thing as too much cash
in your bank account.

Here’s how much cash you actually need on hand

Figuring out how much cash you actually need in your bank account
is pretty simple.

First, have enough to
cover emergencies and unexpected expenses (in other
words, keep an emergency reserve). A safe guideline is to keep
a minimum of three months’ worth of income in a
liquid savings account.

If you want a bigger safety net, save between six to twelve
months’ worth of income in your emergency fund instead.

Then, keep a cash cushion to handle irregular, one-time
expenses that you can expect, like yearly premiums,
registrations, annual events, and so on.

You can keep this in your checking account so it’s readily
available as those expenses roll around — just be sure to
plan for them instead of letting them sneak up on you.

Take the total amount of an irregular or semi-annual expense and
divide it by twelve. That will give you the monthly amount that
should be included as a line item in your monthly budget. Set
that money aside and put it toward your cash cushion so it’s
available whenever that cost comes due.

Finally, you’ll want to
save the appropriate amount of cash relevant to your short- to
mid-term goals. For example, you
may not need to have all the money necessary to fund next year’s
trip in cash right now, but you do need to identify how much you
can save over the next year to get there.

And that’s pretty much it. Any level of cash
over these markers is likely going to be “too much.” Keep in mind
that this applies to all your cash across all liquid
accounts.

Cash is a great place for safety, but safety doesn’t help you
grow your money. Yes, investments come with risk. But stuffing
cash into a mattress isn’t the smartest financial plan, and I’d
argue that taking that route is as big of a risk as
investing.

The longer you keep cash in a bank account, the bigger the risk
of losing buying power due to inflation. You want to put your
money to work for you so you can take advantage of compound
returns in your investments and grow significant wealth over
time.

Eric Roberge is a certified financial planner and the founder
of Beyond Your
Hammock. This is an adapted excerpt from his free ebook,
“Going
Beyond Simple Money: Strategies to Grow (and Keep) Real
Wealth.“