You see it in the headlines and at the grocery store: Prices on food, gas, and other essentials are on the rise. Your cash balances are losing purchasing power in a big way.
Under these circumstances, it’s natural to consider moving that cash into other assets. Those other assets could be gold, commodities, stocks, and even Bitcoin, depending on your outlook. But one legendary investor might tell you something completely different.
Buffett on cash reserves
Draining your cash reserves when inflation is running high can can make sense from a numbers perspective. But the move can also ultimately prove counterproductive to your finances. This is a point billionaire investor Warren Buffett has promoted recently: Low cash reserves harm your financial independence.
Buffett brought up the cash topic in his latest letter to shareholders of Berkshire Hathaway, the investment conglomerate he chairs. Referencing his preference to hold at least $30 billion in cash and cash equivalents at Berkshire, Buffett said, “We want your company to be financially impregnable and never dependent on the kindness of strangers (or even that of friends).”
Investors need cash
Buffett’s words apply as well to personal finance as they do to corporate finance. Having ample cash savings gives you flexibility to manage through unexpected circumstances — without having to borrow from the bank or your great-aunt Susie.
Unexpected circumstances include job loss, car wrecks, home maintenance issues, and health problems. And specific to investors, there’s the added dynamic of down markets to manage.
When the market’s down, pulling money from investment accounts can be more expensive than borrowing. You’ll get less value than you’d like on the liquidation. And you’re left with a lower share count, which means less opportunity to benefit from an eventual recovery.
That’s why investors need cash on hand, regardless of what’s happening with inflation. In the face of emergencies, cash protects investment returns.
How much cash do you need?
Financial experts recommend having enough cash to cover three to six months of living expenses. You can refine this guideline with some quick analysis on your income and spending.
Questions to consider include:
How stable is your income? Job loss is one of life’s most challenging financial emergencies. If you work in a high-demand role or earn income outside your job (say from dividends or rents), you can manage with a lower cash balance. If you earn irregular income or your job outlook is unstable, target that six-month balance or higher.
How long could you survive on unemployment income? If you spend a high percentage of your income today, unemployment won’t come close to maintaining your lifestyle. In that scenario, a high cash balance is warranted.
What are your insurance deductibles? At a minimum, you need enough cash to cover your largest insurance deductible.
Do you have insurance gaps? You might live in a flood zone and not have flood insurance, for example. Know where your risks lie, and plan your cash balance accordingly.
Cash as insurance
Buffett values the role cash plays in his business, even if the return metrics don’t quite make sense. Applying the same mindset to your own finances can improve your financial flexibility and protect your investment returns.
If the loss of purchasing power bothers you, think of it as an insurance premium — one that’s safeguarding your higher-growth assets from unexpected liquidation.
Catherine Brock has positions in Bitcoin. The Motley Fool has positions in and recommends Berkshire Hathaway (B shares) and Bitcoin. The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), short January 2023 $200 puts on Berkshire Hathaway (B shares), and short January 2023 $265 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.