Quite simply, a Cash Reserve is an amount of money set aside for a rainy day. Or a rainy year. Or years. You know, what we used to call “savings”. But Cash Reserve sounds so much more fancy so let’s call it that.

Must Be Nice

First, I have to acknowledge that we’re coming from a place of privilege if plans include a Cash Reserve. Many Americans would struggle to afford a sudden $400 emergency expense. My hope is that fewer will struggle as they approach retirement but some will even then.

When faced with a hypothetical expense of $400, 64 percent of all adults in November 2020 said they would have covered it exclusively using cash or its equivalent

Report on the Economic Well-Being of U.S. Households in 2020 – May 2021

The Cash Reserve is not used for the same purpose as a typical “rainy day fund”. It’s primary purpose is to cover your Gap expenses (see Gap Planning) during any of the following scenarios:

You Can’t Sell Stocks and/or Bonds

When you predict the market, you’re predicting climate not weather. It may be reasonable to target modest growth over a thirty-year retirement window. But some years will exceed your target (yay!) and others won’t (boo!). Your Cash Reserve should cover the Gap during down market times.

Let’s say you’re getting $1500 per month in Social Security and drawing $400 per month from a pension. Your retirement expenses total $2400 a month, so your Gap would be $500 ( $2400 expense less $1900 income). In good years you plan to draw that Gap from your 401k or, perhaps, some stocks you’re holding.

Now, let’s say you hit a bad year. Stocks flatline or worse. What you don’t want to do is, as the specialists say, “realize the loss”. That’s fancy financial talk for selling your stocks for less than you planned. This is where the Cash Reserve comes in to play: instead of selling stock or drawing from your 401K, you make up for the Gap by drawing from your Cash Reserve.

You’re Not of Age to Draw Pensions, Social Security, or Whatnot

Not everyone chooses to take Social Security (SSI) payments at 62. Some wait until 67 while others push it out to 70. The simple truth is, the longer you hold out the bigger the payout. Sadly expenses can’t be put off so you’ll need a plan to cover the Gap.

Using the above example, with monthly expenses coming in at $2400, less pension income of $400, you’d need to cover a Gap of $2000. In this case your Cash Reserve would need to see you through until your SSI is available. Same applies if it’s an annuity payment or other income you need to wait for.

How Long Should the Reserve Last?

Ideally a Cash Reserve should last you two years, especially if you’re planning to use it to cover market downturns.

Obviously, if you’re using it to defer SSI then you need it to last from retirement until you begin collecting Government dollars.

Just remember a few things when figuring out your Cash Reserve target:

• It’s just the Gap, not the whole thing: funds make up for missing income for a short period of time
• Don’t mix: reserves should be kept separate from emergency savings, tax payments, etceteras
• Cash means Cash: you’ll need immediate access to them and they can’t be tied to some stock or bond; put the reserve in a special savings account to keep it safe

Ideal and actual don’t often meet. You get the Reserve you can afford, whether it’s saving up before retirement or selling off property during your leisure years. The important thing is to have some cushion so you’re not forced into realizing loss.

Alternatives to a Cash Reserve

So long as you know what your Gap is then you’re ahead of the curve. Take the market downturn example, above. That Gap was $500 per month which would mean an ideal Cash Reserve of $12k ($500 times 24 months). Say you can’t save $12k and cover all other expenses and savings targets. Well, you have a number, so maybe your Cash Reserve looks like …

• Side Hustle Reserve
  Maybe you don’t plan to work during retirement but, in down times, you’d consider getting a job that brings in $500 per month. That’s a low enough threshold to do 12-15 hours/week at minimum wage. Not great but there are some cool jobs at that level, maybe working for a non-profit or other rewarding organization that’s not just shoveling fries into a bag.
• Property Reserve
  Collectibles, second cars, and other disposable property could be considered a form of Cash Reserve. While better than nothing there is a real risk with this approach in that you’ll need to find a buyer for The Thing and they’ll need to agree to your price.
• Budget Reserve
  Create a second “hardship” budget that scales back on expenses during the period you would otherwise use a Cash Reserve.

None of the above are ideal to be sure. The important part is to know your Gap and have a plan to cover said Gap during bad times. The sad truth is you can plan now or plan in real-time, which we know is a whole helluvalot harder.