It depends, but let’s clearly define what’s cash first. Cash is a currency that is readily available for you to use to fund your purchases. Hence It is liquid by nature, and generally stable in terms of its pricing; little volatility.
This is my definition of cash, and everyone else have their own definition. Once you have a definition of cash, then you are able to work out a proper framework for yourself and see how much cash you should hold.
This is actually a very intricate matter, whether you are an individual, or a corporation. It’s intricate because of the main 2 variable factors; your short and mid term needs, and your existing cash flows from your job, businesses, or investment dividends.
If you are on a conservative side, usually you will tend to have an excess cash holding. There’s no issues with that actually. Most importantly is you can sleep well every night. However, if you can still sleep well every night, and make your money work harder than cash, why not?
On the other side, we have people who are always leveraging, and hence left with little or no cash on hand. They are fully invested most of the time, and their upcoming cashflow will tend to fully allocated to their next investment. Such group are often associated with higher risk higher rewards category. When times are good, they reap the most rewards and are proponents of leveraging. However when times are bad, and real bad, these group of people will be badly exposed.
What then should be an appropriate allocation of cash then?
There’s no hard and fast rule, but you definitely want to have a proper principle or framework to guide you. A framework will allow you to check whether you are under-cash or over-cash. Hence let’s explore this framework. Whether you are a SME owner or individuals, it applies to all.
1. Emergency needs; the amount of cash must be able to last us for 3, 6, 9, 12, or even 24 months in the event of emergency situations. Such situations could be a loss of job, pay cut, economic downturn and poor business turnover. One should have sufficient insurance coverage illness and hospitalization, hence I didn’t include this as a emergency situation unless you are UN-insurable. Therefore, you decide how many months of cash you may need for emergency needs. My recommendation is 6 months. If you lose a job, you probably will get some form of compensation that is 1-3 months of your salary. If you can’t find a job within 3 months, likelihood is you will find some freelance job to do. In a era of gig economy supporting the major economy, it’s hard to find a job to make some money. If you are running a business, you probably need 12 months of cash then. Just have a look at Covid period where too many businesses were wiped out because of liquidity crunch.
2. Opportunity needs; do you have ready cash to fund an investment property which is depressed in price? At least a downpayment and stamp duty fee of total 30% of the purchase price. If we are talking about a $1m property, then you need $300,000 of cash on standby. Of course, for Singaporean who can use your CPF to fund part of the purchase, your cash on standby can be significantly reduced. Do your own math. You definitely want to have such funds for opportunity needs, as you don’t want to miss on these great sales when crisis arrive. Opportunity needs also includes, and not limited to, stocks investment, business ventures, private equity investments as well.
In summary, your cash on hand should be able to handle a 危机 (Danger & Opportunities).
As I mentioned earlier, the intricate matter is we have upcoming cashflow from our jobs and business operations. Hence, if your cash on hand already exceeds the amount which you set to have, you may want to actively deploy the excess cash. The whole game is to make your money work harder for you. Remember, there’s only 2 ways to make an income; people at work, and money at work.
If you have more cash piling up, more often than not, you have few opportunities to deploy those cash, which then results in over storage of cash. Warren Buffett has a huge collection of superior companies managed by excellent managers who are good at managing the company. His main job is to help deploy those excess cash from his portfolio companies, less for operational needs, into investments. For many of us, our excess cash are often stashed away in banks instead.
An average person who has both an emergency account and opportunity account will on average set aside about $300,000-$500,000 in their bank savings account. Can you imagine the opportunity cost if you were to park it somewhere else?
A 3% difference would mean an opportunity cost of $15,000. If you were to compound it over 30 years, that opportunity cost is over $700,000!!! You didn’t lose it, your banker pocketed it on your behalf.
Let go back to our definition of cash again; a currency that is readily available for you to use to fund your purchases. Hence It is liquid by nature, and generally stable in terms of its pricing; little volatility.
Using the above definition, we can then think of a few examples of cash alternatives other than bank savings account
1. Fixed Deposits with the bank. Short term 6/12/18 months fix deposits at this moment is pretty attractive with interest of up to 4.3% p.a. High liquidity is there and if you terminate the contract, you be able to access your funds in 2-3 days time. However do note that if you terminate it prematurely, all interest accrued will be forfeited and you only will get the base interest rate of 0.05% instead.
2. Treasury bills; in Singapore we have the short term 6/ 12 months treasury bonds, as well as the Singapore Savings bonds (10 years period). I like this source as it’s backed by government, and is considered the safest asset class in the world.
3. Money market funds; it’s actually a basket of top quality bonds, and make up a fund altogether. Very safe as well, but do look at what’s their underlying assets though. Generally it’s pretty safe and liquid.
4. Credit line; since I define cash based on its accessibility and liquidity and its stable nature, actually most huge corporations and wealthy people use the credit line facilities, which is offered to them by their bank, to fund for emergency and opportunities.
If you were to delve deeper into research of the successful and most companies, in particular during the Covid crisis period, you will realize that many of them increased their credit line in preparation for crisis management, and also opportunistic management.
Which type of people or corporations would have such facilities then? Only if you are credible, even in crisis, and have many business dealings and be of importance to the bank, then you will have such facilities. Bank wants to make money and they do by lending you money. If you are a credible person, and would want to borrow a lot of money, they willingly will lend it to you, knowing that you highly likely will pay it back.
Hence, such source of cash is the best option available to fund your emergency and opportunities needs. This allows your existing cash on hand to be further deployed into productive assets, and hence increasing your wealth.
If you study deeply, such credit facilities is available to all of us if you own life insurance policies. In fact this is one of the best facilities as your cash policies are already being used as a collateral when you borrow from the insurer. No processing fees, no early repayment fees, and best of all, no repayment schedule.
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