For decades, one of the most common pieces of financial advice has been simple: keep three to six months of expenses in an emergency fund.
For many households, that is sensible advice. But it is also a rule of thumb built around a fairly narrow assumption: that the best way to prepare for an unexpected expense is to keep enough cash sitting on the sidelines to cover it.
For investors with substantial liquid assets, there may be a better question to ask:
Do you need cash, or do you simply need reliable access to liquidity?
Those are not necessarily the same thing.
Imagine a household that wants to be able to access $100,000 if something unexpected happens. One approach would be to keep the full $100,000 in cash indefinitely.
Another might be to keep $25,000 readily available while allowing the remaining $75,000 to stay invested in a diversified portfolio, with the ability to raise additional cash through portfolio sales or, where appropriate, borrowing against investment assets.
That distinction can matter.
Suppose the $75,000 earns an illustrative 6% annually in a diversified portfolio rather than 3% in cash. After five years, the portfolio would be worth roughly $100,000, compared with about $87,000 in cash.
That is a difference of approximately $13,000.
In other words, maintaining excess cash has a cost even if the emergency never arrives.
Of course, accessing liquidity another way is not free either. Selling investments can create tax consequences. Borrowing against a portfolio creates interest expense and introduces leverage. Market conditions matter. No single source of liquidity is appropriate in every situation.
That is precisely why we think it is useful to move beyond the idea of a single “emergency fund” and instead think in terms of a liquidity system.
A liquidity system can include several layers:
Immediate liquidity: cash available for normal spending and near-term needs.
Portfolio liquidity: marketable investments that can be converted to cash relatively quickly.
Contingent liquidity: borrowing capacity that may provide temporary access to funds when selling investments is undesirable.
The objective is not to eliminate cash. Cash remains useful.
The objective is to avoid holding more of it than your financial situation actually requires.
A traditional emergency fund is essentially a stockpile. A liquidity system is a plan for where money would come from, how quickly it could be accessed, and what that access would cost.
For investors with significant liquid assets, that can be a much more useful framework than simply asking whether six months of expenses are sitting in a savings account.
The better question may be:
If you needed $100,000 tomorrow, where would it come from?
At Hanover Advisors, we help clients think beyond simple rules of thumb and build portfolios around how their money actually needs to work. That includes not just how much to invest, but how to maintain liquidity, where it should come from, and what it may cost to access.
If you are holding significant cash simply because you are unsure what you might need later, we can help you evaluate whether that money is serving the right purpose. Contact Hanover Advisors to schedule a portfolio review and build a liquidity strategy designed around your actual needs.