How Much Cash to Hold: Start with When and Why You Need It
Cash serves different roles for living expenses, planned spending, and future investments. Calculate how cash allocations affect downside protection and participation in gains.
A cash allocation cushions price fluctuations in the account and reduces the chance of having to sell assets hurriedly to meet expenses. However, it reduces participation when risk assets rise and can create purchasing-power concerns when held for a long time. Rather than assuming more cash is always better, first distinguish funds by when and why they will be used.
Divide the money in one account into three purposes
Treating emergency funds, money earmarked for dated expenses, and cash awaiting investment opportunities as one balance overstates actual flexibility. Label each amount by purpose and subtract already committed spending from cash available for investment. If you invest even your living-expense money during a stock market selloff, you may have to sell again at low prices when you subsequently need cash. Cash helps reduce these forced decisions as well as providing buying opportunities.
Check the structure even when a product is called a cash equivalent
Do not treat all near-cash assets, such as bank deposits, short-term bond products, and MMFs, as having identical terms. Withdrawal availability, potential fluctuations in principal, early termination conditions, and applicable protection schemes can differ. A foreign-currency deposit's won value changes even if its foreign-currency balance stays the same. If emergency savings are intended for immediate spending in won, accessibility and currency must fit the purpose before yield does.
Quantify opportunity cost and maintain your rules
Counting only the gains missed because of cash during stock rallies makes it easy to forget its cushioning role during declines. Focusing only on downside protection, however, overlooks the cost of waiting a long time for opportunities. Because an optimal allocation can only be determined with knowledge of future markets, write down in advance the conditions for deploying cash and the minimum earmarked funds to retain. Also decide when to review the plan if the expected opportunity does not arrive, avoiding an indefinite wait.
The psychological room provided by cash can also be assessed in terms of your ability to follow through. Having funds to meet regular expenses can give you time to examine information without hastily changing your investment thesis. Still, regularly reconcile balances against their designated purposes so that a feeling of security does not justify holding a large amount indefinitely. Recalculate cash needs when spending is completed or income stability changes.
Worked example
Hypothetical example: A KRW 10 million account holds KRW 7 million in stocks and KRW 3 million in cash, ignoring cash returns and costs. If stocks fall 20%, the loss is KRW 1.4 million and the overall return is −14%. If stocks rise 20%, the overall return is +14%. If KRW 2 million of the cash is committed to next month's spending, only KRW 1 million is available for additional purchases. Distinguish the displayed cash allocation of 30% from the 10% available for investment.
What to check
- Have you excluded committed spending from available cash?
- Have you checked withdrawal and pricing conditions for cash-equivalent products?
- Does the cash currency match the currency of the required spending?
- Have you written down deployment conditions and a date to review the plan?
Sources and primary materials
This is educational material about research methods. For an actual company decision, verify the filings and primary sources for the relevant period.