Once you have identified your budget and minimum amount of savings you need to put back each month, your bank account should continue to grow accordingly. The next step is to determine the account balance you need for your cash and cash equivalent reserves. This is the combined checking, savings, and money market balance you should consistently have available to you.
There is no magic number in determining this amount. Some people recommend 3-6 months of income, but I typically recommend 3-6 months of expenses. Talk it over with your spouse to determine what feels right. This is more of an emotional decision rather than an analytical decision.
Current economic conditions suggest a higher-than-normal inflation period could be on the horizon. If this is true, too much cash during this time is wasteful and will ultimately allow inflation to erode the cash to lesser values over time. Inflation is harsh on lazy money. To combat inflation, it might be time to move excess cash (above the minimum amount needed as reserves) to taxable investments to be involved in economic activity.
A taxable investment is just that: an investment account established on an after-tax basis. There are no penalties to access the funds, there are no tax deferrals, no contribution limitations, and no distribution mandates. A taxable investment is a liquid account, so the investment account can serve as a backup to cash reserves. This style of investment account is subject to capital gains tax treatment, so it’s important to understand the rules, especially if the investments are self-directed. It’s also important to have an investment strategy that is capital-gains-tax-friendly to maximize your return.
After the minimum account balance in your cash reserves has been achieved, it’s time to start thinking about a longer time horizon. For example, you may determine $50,000 to be suitable as a minimum cash reserve amount. When your checking and/or savings account reaches that balance, all remaining or “overflow” cash can be redirected to a taxable investment account. Each month, after all the basic expenditures are complete, review the account balances in the bank accounts. If there is $55,000 in the cash accounts, then it may make sense to contribute $5,000 to the taxable investment account. If there is an overage after the next month’s expenses, then you can continue this strategy.
Scraping the amounts above the minimum bank account balance to put towards an investment strategy is a simple way to make sure your personal accounts aren’t too cash intensive, especially if inflation is indeed on the rise. If, for some reason, your cash accounts are lower than the threshold you have established, you have a couple of options: 1) you can simply not contribute funds to the investment account the next month to recover the account balance or 2) if necessary, you can raise cash from the investment account and put in you cash account. Understand there could be tax consequences by selling taxable investments, so consult your advisor beforehand.
In many investment studies and simulations, time in the market is more impactful than the timing of the market. If inflation is indeed on the rise, then you might be able utilize both. Creating a steady investment strategy to maximize your monthly saving habits to stray from storing lazy money and gravitate towards participating in economic activity might elevate your financial planning from complacent to proficient.