Do you keep a spare tire in your car? You hope you will never have to use it, but it is good to know it is there in case you have an emergency with a flat tire. The same can be said of a cash reserve in retirement – you would rather not dip into it, but it is good to have in case of the unexpected.
Cash Reserve in Retirement
Entering retirement, many individuals possess a) investments that have potentially benefited from years of growth and compounding, b) a manageable debt position, and c) a cash reserve for emergencies. Determining the appropriate size of this cash reserve can be challenging as it needs to cover unforeseen expenses while not being excessively large, subjecting it to inflationary erosion. However, the answer varies for each retiree.
As retirement approaches, investors should consider reducing certain investment-related risks. Maintaining a cash reserve can help you address the following:
• The Unexpected: Emergencies such as health crises or home repairs can arise, disrupting monthly cash flow. Having a cash reserve can provide financial relief during such times.
• Market Volatility: Maintaining adequate cash reserves may help individuals maintain a long-term perspective during market downturns. This liquidity can enable investors to capitalize on investment opportunities while weathering market fluctuations.
• Sequence of Returns Risk: Early negative returns in retirement can significantly impact the longevity of retirement savings. A cash reserve can mitigate this risk by providing a buffer against market fluctuations.
Using The Bucket Approach
The bucket approach is a financial strategy that can aid in building a cash reserve. Typically, the first bucket holds several years’ worth of cash reserves, while subsequent buckets contain longer-duration fixed-income investments and equity positions for growth potential. Determining the appropriate allocation to cash reserves is a personalized decision that may benefit from consultation with a financial professional.
https://www.kiplinger.com/article/retirement/t047-c032-s014-how-much-cash-should-retirees-hold.html
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