Cash Management For The Early Retiree

From age 18 to about 35, I didn’t believe in emergency funds.

I didn’t understand the logic of having six or twelve months of cash just sitting there, earning a pitiful amount of interest. Especially when you factored in the opportunity cost of the lost gains on that capital.

After all, $25,000 at only an 8% return will turn into $250,000 in 30 years. And I don’t know about y’all, but I aim to do a little better than 8% over time.

Besides, I had other things that helped protect me against emergencies. For short-term issues I had multiple credit cards, each of which had five-figure limits. I also had an ever-growing collection of cash-flowing assets, including real estate, a private mortgage portfolio, and, a little later on, stocks. The stock portfolio was liquid and could serve as a last-ditch emergency fund.

And then, later on, I got married. If worse came to worse and I lost my job, it was unlikely my wife would lose her job at the same time. Passive income, baby!

Some of you are probably waiting for the other shoe to drop, but the end of this story is pretty anti-climactic. It worked out just fine for us. We had emergencies just like anyone else, but they were easily handled — and all without paying a nickel of credit card interest.

That all changed once I started to think of retiring early. Suddenly, the downside mattered. I realized I would only get one shot at this early retirement thing, and so I wanted to bulletproof the process. I accumulated enough dividends to account for about 110-115% of my spending needs, eventually increasing that to 125%. I started a passion project (this newsletter!) which would provide a little bit of income. And I started leaving a lot more money in cash, pumping up the ol’ emergency fund for the first time in my adult life.

Today’s edition of the newsletter will focus exactly on that, going through the exact way I handle my cash balance as an early retiree. Let’s dive in.

How much to keep in cash?

I know y’all are looking for a specific amount I leave in cash, and want me to reveal that our cash cushion is exactly $12,345.67. That would be satisfying from a OCD perspective, it but doesn’t really have much more use than that.

Why? Because the level of cash you keep on hand should be directly reflective to what you spend. Heavy spenders will need more cash, while the more frugal half of you reading will need a lot less.

So, keeping this in mind, all cash levels I’ll talk about will be reflective of your spending level. I’ll say things like six months’ worth of spending, or a year’s worth of spending.

With that out of the way, let me say exactly how much we keep in cash at any one point.

We keep between six months and one year’s worth of spending as cash.

Y’all might think that’s a bit of a copout, but like any good financial decision, the real answer is ‘it depends’. We have fairly low fixed expenses — paying off the mortgage sure helped here — but higher variable expenses that might be higher one month versus the other.

For example, so far in June I went to Game 1 of the Stanley Cup Finals, and I’m currently on a road trip to Winnipeg. So far I’ve had the opportunity to meet some of you, did some golfing, caught up on reading, and mostly just relaxed. It’s been a great month so far, but it’s been a little expensive. I know I’ll cringe a little bit when I look at my credit card statement at the end of the month.

Because of that, my cash reserves will take a little bit of a hit. I’ll have to withdraw some dividends from the ol’ brokerage account to replenish them.

Generally, we spend more money in the summer. The travel opportunities are better, I’m trying to golf as often as possible (which costs $$$), and we’re more inclined to go out and about. We hibernate more in the winter. Now that I know this, I’ll stack more cash in the first few months of the year and then slowly deplete it over the summer.

As of today, we have about 0.8x of our yearly spending in cash, and I’m slowly using dividends to bring that back up. I’ll let a month or two worth of dividends accumulate in our various accounts and then sweep them over to the cash pile.

Cash management during market selloffs

Cash management is a little trickier when the market has fallen, since I’m usually looking to buy at that point.

What I’ll do is in those situations I’ll drop my cash cushion to a minimum level and put that cash to work in stocks. That minimum level is about six months worth of spending — I simply won’t go below that. I don’t care how enticing the opportunity is, I just won’t do it. I would’ve in the past, but things are different now.

The first step in such a situation is to reinvest 100% of my dividends. They don’t get swept, they get put back to work. If the buying situation persists, then I start moving money from cash balances back into the market.

One thing I won’t do is dip into margin, even though Wealthsimple makes such a thing fairly attractive. I’m only interested in buying with my cash.

How to maximize your cash’s return

The issue with having a fat emergency fund is the opportunity cost. That’s a big deal, especially when you’re first starting out and you don’t have much tucked away.

But even for those of us whose emergency funds aren’t a huge portion of our net worth, we still want to earn something on that cash, dargbloomit! We just can’t handle having the money just sitting there, slowly losing pace to inflation.

The popular solution over the past few years was to use the CASH ETF (TSX:CASH). It stashed your cash in high-interest savings accounts offered by some of Canada’s top financial institutions, offering a yield that flirted with 5% for a little while.

In fact, when I kept buying beaten-up dividend stocks back in 2023 I had people constantly questioning my decision. Their logic was I could get 5% yields via that ETF, and without taking any principal risk.

That was true at the time, but three things have happened between now and then:

1. The stocks I was buying went up

2. Their dividends increased

3. And CASH’s yield fell. Hard.

These days, you’re only getting about a 2.5% yield from this product. That’s a lot better than zero, but you can earn more.

One suggestion is to switch to a money market ETF. There are several of them out there, and they generally offer yields in the high-2% range. That’s a little better than CASH.

You can get yields flirting with 4% if you put your dollars into USD money market ETFs, but I don’t like those because you’re taking currency risk. A 4% move in the currency translates into a year’s worth of lost returns.

Think it won’t happen? Nice try. It happened in the last month alone.

None of these products do it for me any longer, so I’ve devised a better system. I chase bank account promos.

This takes a little bit of work to set up, but once you’ve set up accounts at 5-6 different banks you’re in business. You simply move your cash into the account that offers the best bonus interest.

For us, today, that’s Royal Bank, which is currently offering 4.7%. That promo is good for another couple of months. Then, at that point, we’ll transfer that money to the next bank.

People always scoff at how much work this is, but it’s marginal once you’ve opened up the accounts. All you have to do is keep track of when the promo period ends (a calendar notification in your phone will do the trick) and pay attention to your email.

We also use WealthSimple as a place to park cash. We get the best rates as Generation status, and there are ways to goose that rate a little further.

The point is this. Yes, it does take a little extra work. But if I have an average cash balance of $50,000 and I earn 4% on it versus 1%, that’s a difference of $1,500 per year. I’ll gladly work 5-10 hours a year at that.

The bottom line

I believe that there’s no such thing as a one-size-fits-all emergency fund.

A couple with zero children and one government job needs a far smaller cushion than a single freelancer who is dependent on short-term contracts. To not weigh these factors into your decision making process is silly.

In terms of my early retiree emergency fund plan, I erred on the side of caution. Despite the fact that dividends tend to go up over time and are much more stable than share prices, I still added in various safety tools. I don’t spend all my dividends. I keep a 6-12 month cash balance. And I use knowledge gleamed from other years to realize when we spend the most.

Because, as I like to say, I only get one shot at this early retirement thing. I don’t want to screw it up.

Earning interest on my cash is just icing on the cake. I can earn a little bit by using various ETFs, or I can take a more active approach and earn a little more. I enjoy the challenge of maximizing the value out of what’s a really boring asset class, so I take the active approach. But if you’re lazy, then you don’t have to.

The important part is this. I took less risk as I got older, which is the prudent way to go about things.

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