Formulate a Financial Plan

Know Your Net Worth

Manage & Minimize Debt

Accumulate Assets

Budget to Live Within Your Means

Understand Investing Basics

Plan for Retirement

Insure People & Property

Deal with Financial Advisors

Review Your Employment Contract

Make Plans for Your Estate

Make Good Decisions


Suppose you have a sudden need for cash to fix a leaking roof, repair a car, or to make an unexpected tuition payment for a child. Even more urgently, suppose you lose your job or are temporarily disabled. If you don’t have enough cash on hand to cover immediate obligations, you may have to liquidate investment assets or resort to carrying large credit card balances. As already noted, selling assets quickly may lead to significant value loss. Similarly, carrying credit card balances at high interest rates is very costly.

To avoid these negative outcomes you should hold cash and equivalents as a rainy-day or emergency fund. When unexpected expenses arise you can use cash from the emergency fund without disrupting your long-term financial planning or resorting to high-interest credit cards.

A common recommendation is to amass a rainy-day fund equivalent to between 3 to 6 months of non-discretionary expenses. Non-discretionary refers to expenses you’re committed to making—That is, expenses you cannot avoid.

The idea is that if your finances become constrained you can respond by cutting back on discretionary (unnecessary) expenses, leaving you with enough money to cover 3-6 months of necessary expenses.

An alternative rule of thumb is to have an emergency fund equivalent to 6 months’ salary. If your gross monthly salary is twelve thousand dollars, you could hold total cash and cash equivalents (checking, savings, CDs, T-Bills, and money market accounts) amounting to about seventy-two thousand dollars (twelve thousand times 6).

A Roth IRA (discussed in the retirement planning chapter) is viewed by some as a substitute or complementary rainy-day fund. Roth IRA contributions are made with post-tax dollars—money on which you’ve already paid tax. By law, you can withdraw your contributions without penalties. You may, however, be required to pay taxes and/or penalties on any earnings (or gains) generated in the account and withdrawn prematurely. Keep in mind that it may take some time (a week or more) to receive those early withdrawals, making them somewhat less effective for true emergency situations. More importantly, Roth IRAs have very favorable tax advantages, so you don’t want to prematurely withdraw funds from them.

Money market accounts offered through qualified accounts, such as 401(k)s, are not counted toward our rainy-day fund totals because hefty penalties may apply to withdrawals. If you elect to withdraw money from a 401(k) account, you may have to pay taxes on the amount withdrawn and an additional 10% penalty.

There is one other benefit to holding a rainy-day fund: when prices of securities decline dramatically, you can opportunistically use available rainy-day cash to purchase those depreciated assets (e.g., stocks, bonds, or real estate). Some investors gradually increase their cash holdings as markets reach high values, precisely so they will have money available after inevitable market crashes. 


Where Does the 3-6 Month Guideline Come From?

There’s no deep science behind the guideline to hold the equivalent of 3 to 6 months’ salary in your rainy-day fund. The recommendation is based on practical considerations. If you lose your job it may take you somewhere between 3 to 6 months to find another. If you become disabled, it may take you a comparable amount of time to recover and return to work, or until your long-term disability policy is triggered and begins to pay you benefits.


Why Not Hold More Than 6 Months of Salary in Cash?

If having more cash or liquid assets is good, why not hold more than 6 months of salary or non-discretionary expenses?

To arrive at the answer, recall that the more liquid an asset, the lower its return. The most liquid form of cash is, of course, coins and bills.

How much interest do you receive for holding physical cash?


What about the next most liquid category? How much interest do you receive on your checking account?

Effectively zero!

What about Savings accounts?

A very small amount, generally less than one or two percent. During periods of very low interest rates, savings accounts may pay interest of 0.3%, or less, annually.

I have a relative who is a very accomplished physician. He’s so distrustful of financial advisors that he decided to keep all his money in a checking account. For several years his checking account balance was over $300,000—far more than was needed for a rainy-day fund. While we can all sympathize with his distrust of advisors, he could (and really should) have placed most of this money in higher yielding assets. At the very least, he could have put some of the money in FDIC insured CDs, earning a few percent a year to keep up with inflation. Instead, he was effectively giving his bank an interest-free loan!

Thus, the answer to the original question is that you can hold more assets in cash and cash equivalents, but those assets aren’t working for you. They’re not helping you to grow your wealth because the returns they offer are very low. To reach your financial goals you want as much of your money as possible to be productive over a long period of time.

Cash is safe, but it’s not very productive. That’s why we invest most of our money in stocks, bonds, and real estate. Because we want and need those higher returns to grow our pillars.

US Government-issued Treasury securities are universally viewed as the safest and most liquid investments, and in the USA interest earned from these instruments is exempt from state and local taxes.

If you’d like to include some US Government Treasury securities in your cash holdings you can cut out all the middlemen and participate directly in auctions of these securities by opening an account at  

This is a government site that allows you to purchase various Treasury securities including: Treasury Bills (T-Bills) with maturities up to one year; Treasury Notes with maturities of 2 to 10 years; Treasury      Bonds with maturities over 10 years; Treasury Inflation-Protected Securities (TIPS) with maturities between 2 and 30 years; Medium-term Floating Rate Notes (FRN); and Savings Bonds. While Treasury securities in general are considered highly liquid (i.e., you can sell them relatively easily), in your cash & equivalents pillar you may want to stick with short-term T-Bills.

You can link a bank account to fund TreasuryDirect purchases and you can automate reinvestments, minimizing the number of times you must login to initiate transactions.

Treasury securities can play an important strategic role in the management of your nest egg. You can decrease your overall nest egg risk exposure by shifting money out of riskier investments (such as stocks and corporate bonds) and into Treasury securities (or vice versa to increase risk exposure).

Treasury Bills are discount instruments. You buy them at a discount to the promised or face value. The difference between the face value you receive at maturity and the amount you pay is your earned interest.

Here’s an example: I like to hold a diverse set of assets in my rainy-day fund, with at least some of those assets providing a return commensurate with inflation. I recently ordered a face value of $5,000 in 4-week maturity T-Bills. When the auction took place I ended up paying $4,990.67. In my case the interest over the 4-week period was,

( $5,000-$4,990.67 ) / $4,990.67 = 0.1869%

Annualized, this is equivalent to 2.45%. At the time the best savings account deal my bank offered was 2.1% and that required a minimum daily balance of $25,000 for 12 months! TreasuryDirect offered a higher rate of return over a much shorter horizon (more flexibility for me) and a much lower required minimum than the bank—you can invest as little as $100 at TreasuryDirect.

My rainy-day fund consisted of checking and savings account balances, along with several 4-week T-Bills. The latter had staggered maturities ensuring that I was never more than a week or so from having access to cash.   

For convenience I elected to automatically reinvest my T-Bills three times (for three consecutive 4-week periods.) I could have automated reinvestments for a much longer period. TreasuryDirect allows me to stop reinvestments if I need the cash.



Use the attached Cash and Equivalents Allocation Template to assemble your rainy-day fund using cash and cash equivalent instruments including checking and savings accounts, CDs, etc. Replace the sample numbers provided in the template with ones reflecting your household circumstances. Add rows as needed, especially to distinguish different maturities.


Related Links:

Ally CD Ladder

Schwab on Bond Ladders


Yuval Bar-Or

28/01/2021 02:10 PM

Does cash held in retirement accounts count toward our rainy-day fund?

Yuval Bar-Or

28/01/2021 02:25 PM

Cash held in retirement accounts does not count toward our rainy-day fund because, in general, penalties apply to premature withdrawals from such accounts. We may be able to use such cash for an emergency expense, but unless we are old enough to begin taking distributions from retirement accounts (age 59.5), we'd be hit with taxes and a ten percent early withdrawal penalty. This makes cash in retirement accounts illiquid in the sense that we can't access it without suffering a significant value-loss.

Yuval Bar-Or

31/08/2020 10:11 PM

When interest rates dipped near zero and into negative territory I stopped automatic reinvestments in Treasury Securities at TreasuryDirect and instead hoarded some of that cash in anticipation of acquiring some rental real estate. Real estate CAP rates (measures of return) were much more favorable at the time than many other asset classes.