To live comfortably as a senior, you'll need savings. And it's a good idea to house the bulk of your savings in an IRA or 401(k) for the tax benefits involved. Both of these accounts allow you to invest your money so it ideally grows into a much larger sum over time.
But should you invest all of the money you're earmarking for retirement? Or should some of it sit in a savings account so you have some cash on hand?
Your strategy should hinge on your age
When retirement is many decades away, it's smart to invest your money -- pretty much all of it. Keeping it in cash might earn you around 2% a year or so in interest (keeping in mind that today's bank account APYs of 4% and higher really aren't the norm). But investing it might earn you 10% a year, since that's the stock market's average return over the past 50 years. So you want to capitalize on that growth opportunity.
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However, as you get closer to retirement, it's a good idea to move some of your long-term savings into cash instead of keeping it invested. The reason? Once you retire, you're likely going to be withdrawing from your nest egg regularly. But what if the stock market suddenly tanks?
In that case, you risk taking permanent losses by having to sell investments for money at the wrong time. The same thing could happen to the bond market, too. If you own a lot of bonds and have to sell them at a loss, you're in the same unfavorable position.
That's why it's important to keep some of your retirement savings in cash -- but only once you're nearing retirement. You probably don't want to keep a portion of your nest egg in cash in your 30s or 40s. But if you're 62 years old and expect to retire at 65, that's a good age to start turning some of your assets into cash.
The right amount of cash to have on hand
During your working years, you should aim to have enough cash in an emergency fund to cover three months' worth of living costs at a minimum. For retirement, you'll really want more like one to two years' worth.
The reason? Any market downturn that impacts your portfolio could be lengthy. You want to give yourself the opportunity to ride out a downturn while still being able to cover your bills.
If you keep one to two years' worth of expenses in cash, you'll be able to avoid selling assets for that long. In fact, if you're the more conservative type when it comes to risk, you could even opt to keep three years' worth of expenses in cash. You'll lose out on some growth by doing that, but it might give you more peace of mind.
With that said, different people have access to different income streams in retirement. If you own a rental property that generates steady income, for example, you may be able to get away with keeping a little less cash on hand.
But for the typical person, one to two years' worth of cash in the bank is generally best. Just don't make the mistake of moving that money over too early in life.
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