In addition to monthly and quarterly financial reviews, once a year, I take the opportunity to conduct an annual ‘super report’ on my finances, covering everything from account balances to performance against benchmarks and my financial forecasts to setting my strategy for the next twelve months.
As part of this exercise, I measure a number of ratios, including asset allocations to different classes and how those classes have been performing. When I was initially taking control of my financial future, one of the things I wanted to know what how much cash I could keep available for emergencies.
Early research indicated that approximately six months of income was a good buffer to keep available – if you bring home £20,000 a year, having £10,000 in cash will see you through most crises. Another ratio I came across was the 50/30/20 rule – 50% of your savings should be invested in shares, 30% in bonds and 20% in cash.
Neither of these really stuck with me however as neither seemed to have a particularly strong rationale behind them. Why six months income? What if you brought home £100,000 a year – would you really want to have £50,000 in cash?
Know your goals
Identifying that I wanted to keep a percentage of my income in cash seemed counterintuitive when I was doing my research. Although theoretically, I understood the value of having a cash buffer – watching my savings lose value to inflation was a painful prospect when I could see investment opportunities that yielded 7/8/9% returns.
Today, I keep approximately 10% of my net worth in cash and invest the rest. For me, this provides a suitable buffer to handle emergencies and sudden requirements, but also provides me with sufficient working capital to acquire new assets and take advantage of investment opportunities. When I sell an investment, receive a financial windfall, or when I have accrued more than 15% of my net worth in cash, I have a list of potential investment opportunities I have already researched.
Contrary to many other investors, I don’t conduct research on opportunities only when I have the cash to invest – I research opportunities throughout the year, forming a ‘best-buy’ list which I review on a regular basis to see whether the opportunities still meet my criteria. This means that when I have the opportunity to invest, I don’t need to spend weeks identifying opportunities and can act fast to put my money to work for me.
In my opinion, cash and cash equivalents are incredibly valuable for their ability to provide options in sudden circumstances. When you identify an opportunity, you need to be able to move fast to capitalise on it, not wait around for weeks to release funds to pursue it. Likewise, in the event of a sudden expenditure or catastrophe, having a solid buffer of cash behind you means that you have one less concern to worry about.