28 Apr 2017 Buying Happiness, Part 1: How Much Cash Should You Have?

You might be tempted to think, as I often am, that the business of money is fairly straightforward. Some spreadsheets here, some Monte Carlo testing over there, some budgeting along the way, and ding ding ding! There you have it: A wonderfully black and white sort of product with very little wiggle room for uncertainty, or, more to the point, humanity.

But of course, when you take the time to write it out like that, and then read over it, you realize that such a view is at best incomplete, if not bordering on the absurd. Of course it’s not straightforward. If it was so straightforward, money wouldn’t be a leading cause of divorce and general marital angst, it wouldn’t be a primary driver of all sorts of criminal activity, and it would never, ever, ever keep you up at night.

So, over the next few weeks, we’re going to be writing a series of Briefs addressing the tension that often exists between the straightforward answers to your financial questions and the non-straightforward, staying-awake-at-night, human answers that make up the bedrock of what we do.

Today’s question—How much cash should you have on hand?—has at least one very straightforward answer: Have an emergency fund that covers 3-6 months’ expenses plus whatever you need for known expenses coming up in the short term. And it’s a straightforward answer because, from an investment perspective, cash acts like a drag on your portfolio over long periods of time, and you would, theoretically, be better off putting as much of that cash “to work in the market” as you can.

But we’ve just come to the conclusion that this money business is far from straightforward. So maybe it’s best that we be a bit more careful with our answer.

Michael Kitces brought to our attention this week a fascinating study by a group of researchers in the UK named Ruberton, Gladstone, and Lyubomirsky. The title of the study is “How your bank balance buys happiness: The importance of ‘cash on hand’ to life satisfaction,” and its basic finding was this: “that having cash on hand was positively associated with life satisfaction and well-being, regardless of how much the individual already had in income or investments and how much he/she was spending!”

In other words, when it comes to answering the question How much cash should you have on hand? we as planners ought not say, “oh, well just have an emergency account and no more, because it’ll drag down your portfolio.” Because that’s not necessarily the answer that a unique person with a unique set of life experiences needs to hear in order to live with less worry and more good nights of sleep. Yes, it could be that the minimum emergency account is all you need to sleep well at night, but it could also be that, as Kitces said, “choosing to keep a substantial cash balance isn’t an ‘inefficient investment decision,’ but instead a decision to ‘buy more happiness’ with a healthy allocation of comfort cash!”

So, when you think about the amount of cash you have available to you in a pinch, do you feel good about it? Maybe you don’t feel like you need as much as you have and are concerned you’re giving up too much investment return in the long run. You just happen to align fairly well with the straightforward answer I’ve outlined above. But maybe you think about your 3-6 months emergency account, and you realize you don’t feel that good at all about it and would rather it be more like 12-18 months. Your answer doesn’t line up so neatly does it? Here’s the thing, though: it doesn’t matter how well you align with straightforward.

And there’s a real beauty in that, as long as you’re having honest conversations with us or whoever your financial planner is, and as long as we aren’t staring cross-eyed at our spreadsheets when you do. As always, let us know if you have any questions or would like to learn more about working with us. Stay tuned next week for Part 2 of Buying Happiness!