How Much Money Should I Keep in Cash Before I Invest?

Why do I need cash if I have investments?

Investments and emergency savings have different jobs.

Your emergency savings need to be available when you need them.

Your investments need time.

Imagine you've invested £30,000.

Markets have a bad year and your investment falls to £24,000.

Then the boiler gives up.

The car develops an alarming noise.

And the dog apparently requires medical treatment costing roughly the same as a small family hatchback.

You need £5,000.

If you've got sufficient accessible cash, the investment can potentially remain invested.

If you haven't, you may have to sell some of it while its value is down.

That's the problem we're trying to avoid.

Steve's observation

Your emergency fund isn't sitting there failing to be an investment.

It's doing its job.

Its job is to make sure your long-term money doesn't suddenly have to become short-term money.

That's worth remembering when you're staring at the interest rate and wondering whether every penny should be doing something more exciting.

Is three to six months enough?

Possibly.

Possibly not.

Three to six months is a useful starting point, not a commandment carved into a financial stone tablet.

Two households could have identical monthly expenditure and reasonably need very different cash reserves.

Consider someone who:

• has a secure salary;
• lives in a two-income household;
• has relatively low fixed commitments; and
• has no dependants.

Now compare them with somebody who:

• is self-employed;
• has variable income;
• is the household's only earner;
• has children;
• has significant monthly commitments; and
• owns a house and car that occasionally like to demand money.

The second person might reasonably place a much greater value on having additional cash available.

The question therefore isn't simply:

"How many months should I have?"

It's:

"What could realistically go wrong, and how much accessible money would I want if it did?"

Start with essential monthly expenditure

A useful first step is to calculate what your household actually needs each month.

Not everything you spend.

What you need.

That might include:

• mortgage or rent;
• council tax;
• utilities;
• food;
• insurance;
• essential transport;
• minimum debt repayments;
• childcare; and
• other unavoidable commitments.

Suppose that comes to £2,500 per month.

Three months would be £7,500.

Six months would be £15,000.

You've now got a useful range to think about.

But we're not finished.

Don't forget the things you already know are coming

An emergency fund is for the unexpected.

A holiday you've booked isn't unexpected.

Neither is:

• next year's tax bill;
• replacing a car you already know is on its last legs;
• planned home improvements;
• school fees;
• a wedding;
• moving house; or
• money you've promised to somebody else.

If you expect to need £10,000 in eighteen months, don't count the same £10,000 as both:

"money available for next year's expense"

and:

"my emergency fund."

One pot of money cannot perform two jobs at the same time.

What about money I'll need in the next few years?

This is where timescale becomes important.

MoneyHelper describes investing as generally more appropriate for longer-term goals and says that for short-term goals — up to around five years — savings products may be more suitable. The FCA similarly encourages people to approach investing with a timeframe of at least five years.

Why?

Because investments fluctuate.

If you're buying a house in eighteen months, you don't have the luxury of telling the seller:

"Can we come back to this in three years? The markets are having a bit of a wobble."

You need the money when you need it.

That's why separating short-term and long-term money matters.

Could I keep too much in cash?

Potentially.

Once you have:

emergency money + known short-term expenditure + an appropriate financial buffer,

you might discover that a substantial amount of cash remains which has no obvious short-term purpose.

That's when asking whether some of it could potentially be invested becomes reasonable.

Cash can earn interest, but inflation can reduce its real purchasing power over time.

If £50,000 is genuinely intended for something twenty years away, the questions surrounding it are very different from £50,000 needed next summer.

This doesn't automatically mean the long-term money should be invested.

It means its purpose and timescale justify asking the question.

What about debt?

Before investing, look at what you owe as well as what you own.

The FCA specifically includes dealing with expensive short-term debt among the financial foundations to consider before investing.

If you're paying a very high interest rate on borrowing while simultaneously investing money and hoping to earn a return, you need to understand the trade-off.

Investment returns aren't guaranteed.

Interest charged on your debt generally isn't nearly as shy.

That doesn't mean every debt must always be repaid before anybody invests.

Mortgages and other borrowing require their own consideration.

But expensive short-term borrowing shouldn't simply be ignored because investing sounds more productive.

Where should emergency cash be kept?

The key features are normally:

accessibility, security and an appropriate return.

Depending on the purpose of the money, that might involve instant-access savings, notice accounts, Cash ISAs or other deposit accounts.

But don't chase an extra fraction of interest and accidentally lock away the money that's supposed to rescue you when something goes wrong.

An emergency fund you can't access during the emergency has somewhat misunderstood the assignment.

Also consider deposit protection when holding significant cash balances.

The Financial Services Compensation Scheme protects eligible deposits with authorised UK banks, building societies and credit unions up to the applicable protection limit, subject to its rules. Because protection limits can change, the current limit should always be checked rather than relying on an old article.

A simple three-pot approach

You don't necessarily need seventeen bank accounts and a colour-coded spreadsheet.

Think about your available money in three broad groups.

Pot 1 — Emergency money

Money available for things you didn't expect.

Pot 2 — Planned spending

Money you know you're likely to need over the next few years.

Pot 3 — Longer-term money

Money without a foreseeable short-term purpose that could potentially remain untouched for many years.

Only when you've understood Pots 1 and 2 does it make sense to start seriously discussing whether some of Pot 3 should be invested.

It isn't sophisticated.

But it forces you to answer the important question first:

"When might I need this money?"

What Should I Do Next?

Work out three numbers:

1. Your essential monthly household expenditure.
2. The amount you need for known spending over the next few years.
3. The cash buffer you'd want if your income unexpectedly stopped.

Don't worry about choosing an investment yet.

First establish which money genuinely needs to remain available.

Whatever remains can then be considered separately as potential longer-term money.

And that takes us neatly into:

How Much Money Do I Need to Start Investing?

The Open Door Wealth View

There's a temptation to think cash that isn't invested is somehow being wasted.

It isn't.

Cash buys you something extremely valuable:

time.

Time to deal with an emergency without selling investments.

Time to find another job.

Time to pay an unexpected bill.

Time to allow long-term investments to remain long term.

The objective isn't to squeeze every last pound into an investment.

It's to create a financial structure where your cash can do the short-term jobs and your investments have the time to do the long-term ones.

Understand what each pound is there to do before deciding where it belongs.

Suggested Call to Action

You've built up savings. The next question isn't necessarily "What should I invest in?"

It might be:

"How much of this money do I actually need to keep?"

Open Door Wealth can help you look at your cash reserves, existing pensions and investments, objectives and timescales before you make decisions about investing additional money.