Should Short-Term Cash Be Part of Your Asset Allocation?

A couple of weeks ago, Jacob at My Personal Finance Journey wrote an interesting article asking whether your emergency fund and other shot-term savings should be considered as part of your overall asset allocation. You can read it for yourself here: Should You Include Emergency Fund and Specifically-Earmarked Savings in Your Overall Asset Allocation?

I’m particularly fond of this post for two reasons: 1) It was spurred by a question I asked him in response to the detailed personal financial plan you can find on his site. And 2) It’s a topic that I’ve always had an opinion on, but never really fleshed out.

What are we talking about here?

I’ve talked on here before about the importance of your asset allocation in determining your investment returns. The question here is what money do you include as part of this asset allocation? Do you count your retirement savings and your emergency fund in one big pot? How should you factor in that travel fund you put money into every month? What about the savings specifically earmarked for a down payment?

Jacob’s conclusion was essentially that you can go either way (keep things separate or count them all as one) and be correct. I agree with this assessment. As long as you’ve determined your needs and have developed a plan that meets them, good for you.

But I like to keep them separate. Here’s why.

Reason #1: I don’t need a specific percent of my money for short-term goals

I have an emergency fund. I also have multiple savings accounts specifically marked for different purposes, such as travel and car maintenance. And I have a different location where I’m saving up for a down payment on a house. If I included these as part of my asset allocation, I would need to determine what percent of my overall money needed to be set aside for these purposes.

That’s not really how they work for me. I have a specific dollar amount that I want in my emergency fund based on my living expenses. For things like travel and car maintenance, I have a monthly amount that I set aside that mimics my long-term spending patterns for these categories. For my house down payment, I again simply have a specific dollar amount that I’m aiming for. These needed dollar amounts don’t change if I have more or less money, and therefore really aren’t a percent of my overall net worth.

If I managed them as part of my asset allocation, then the percent dedicated to cash would be pretty high when my net worth was low. As my net worth increased, assuming my needs stayed the same, I would either need to decrease the cash portion of my asset allocation, or I would have more money in cash than I really needed. So it either requires a change in my plan or it causes my plan to get out of whack.

By keeping these short-term savings separate, I don’t have to do any re-adjusting and my asset allocation automatically stays in line with my goals. I have the fixed dollar amount in cash, and the rest is simply invested according to my personal investment strategy. Keeping them separate means I have less work to do to keep everything in line with my goals.

Reason #2: Different goals require a different asset allocation

My longest term savings goal is retirement. A slightly less long-term goal is college savings for my son. My short and medium-term savings include some of the goals mentioned above. Each of these goals have a different time frame and therefore require a different balance between risk and return.

Once again, trying to combine them all into one asset allocation would introduce complexity, as I would have to manage all of those different risk-return profiles in one big pot. Instead, I have an asset allocation for retirement, a different asset allocation for college savings, and a final asset allocation for short-term needs. Managing them each separately actually makes things easier because I don’t have to manage the interaction between them. For example, as my children actually approach college age, I can shift the allocation of my college savings to a more conservative approach without worrying about how that affects my retirement allocation. If they were all considered together, any shift in one would require a consideration of all.


There’s no one way to approach this issue. You have to find what works for you and go with it. The important thing is that you find a manageable way to work towards your goals. I find it easiest to keep things separate for all the reasons mentioned above, but I’d love to hear your thoughts as well.

Other articles I think you’ll like

Planting our Pennies: A detailed look at whether using debt to purchase a home, instead of paying in full with cash, is a good financial decision. I love this because it challenges some of the widely assumed “benefits” of home purchasing.

Stacking Benjamins: A great collection of advice from a lot of smart people on how to make saving money easy. As Joe says at the end, focus on the common themes running throughout and you’re sure to find a successful strategy.

Reaching Financial Independence: Living without a mortgage reduces stress, and increases your ability to do what you truly want with your money.

Fat Free Personal Finance: Really thorough breakdown on why your rent payment and mortgage payment are not comparable. Owning a home is often much more expensive than many people think.

Thanks to these carnivals for including me along with some other great posts!

Carnival of Financial Planning
Financial Carnival for Young Adults
Yakezie Carnival

Start building a better financial future with the resource I wish I had when I was starting my family. It’s free!
23 Comments... Read them below or add one of your own
  • Thanks for the shout out. We don’t really look at the short term cash savings when we consider our asset allocations in our net worth.

  • Holly Johnson June 14, 2013

    I only consider my emergency fund as what it is….an emergency fund. However, I’m starting to wonder if I should whiddle it down a little. I tend to overprepare and I’m probably losing out because I have too much easily accessible cash just in case.

    • Matt @ momanddadmoney June 14, 2013

      Maybe, but it depends on what you mean by “losing out”. If you mean the possibility of higher returns, then yes you are. But based on your early mortgage payment strategy, you know as well as anyone that it isn’t always about maximizing potential returns. If you shift away from the safety of cash, you’d be losing out on security that your family may or may not need. It can be a tough call, but I tend to lean in the direction of safety.

  • Pauline June 14, 2013

    Thank you for the mention Matt!

  • DC @ Young Adult Money June 14, 2013

    Hmmm I definitely see your point. Like Holly, I view an emergency fund simply as an emergency fund. I do think you are spot on that different goals require different asset allocation. Most people I know are much more risk-averse than I am, and I would never expect to have the same allocation as them.

    • Matt @ momanddadmoney June 14, 2013

      There’s definitely no one-size-fits-all approach to asset allocation. I should have put this in the post, but I think as my net worth (hopefully) grows, I may shift to more of a one-bucket mentality. When there’s more money in the pot, the specific purpose of each dollar isn’t as important because you should have enough to cover whatever need comes up.

  • Greg June 14, 2013

    I tend to keep the emergency fund in its own category. Keep it set at a certain level and the rest goes to our other allocations. Like Holly mentions, I probably have that level set too high and could likely afford to put more into my other investments.

    • Matt @ momanddadmoney June 14, 2013

      You can see my response to Holly, but it depends on why it’s that high the first place. Whatever you need to keep yourself financially secure should be in cash, and anything beyond that can be invested. If you have more than you need in cash, then you’re missing out on returns, but sacrificing security in the hope of greater returns is likely not a good strategy.

  • Matt @ momanddadmoney June 14, 2013

    I definitely enjoyed your take. It was a good breakdown. Re-thinking things is always helpful, even if you end up coming back to your original decision.

  • John S @ Frugal Rules June 14, 2013

    Nice thoughts here Matt. We do something very similar and keep our EF separate along with a few other targeted savings accounts for travel, car repair and the like. For us that is completely different from our more long term investing as we have different goals for that. I also keep a small amount of cash in our portfolio so as to be able to take action on an investment if I see an opportunity I want to take.

    • Matt @ momanddadmoney June 15, 2013

      Sounds like we’re in the same boat, except for the cash on hand for investment opportunities. But I think you already know my thoughts there. I do think that having some cash on hand is a good idea if you’re trying to pick stocks, as long as the cash drag isn’t too significant.

  • Your Daily Finance June 15, 2013

    We have an emergency fund and separate savings account much like you do. We have one for travel, gifts/xmas/bdays, and one for car repairs etc. The emergency account is based on having enough for 12 months if both of us lost our income. I don’t include those accounts with my retirements accounts and brokerage. I could but for our purposes I keep them separate. Though you wouldn’t be wrong either or.

  • Jules@Faithful With a Few June 15, 2013

    Great post Matt! I think of it as separate since it is for emergencies. I like to pretend it’s not there til I NEED it.

    • Matt @ momanddadmoney June 15, 2013

      I like to pretty much ignore it as well. I actually have my EF and short-term savings with a different organization than my checking account. I didn’t really do that on purpose, but it helps keep things even more mentally separate.

  • Lindsey @ Cents & Sensibility June 15, 2013

    Hi Matt!
    I treat it as separate because I don’t want to think about it as a “asset allocation”. It’s there strictly for emergencies, I didn’t want to consider it as something that needed to yield a certain interest rate return or plan a portfolio around.

    • Matt @ momanddadmoney June 15, 2013

      Couldn’t agree more. People get very stressed about their EF not earning enough interest, but that’s really not the point. It’s meant to be there for you when you need it.

  • Funancials June 16, 2013

    I don’t think it matters if someone DOES include it or DOESN’T include it, but by definition, cash is a component of asset allocation.

    The reason for asset allocation is because different asset classes offer different returns and carry different risks. Your individual asset allocation should mirror your needs and goals. Choosing to keep cash in a savings account, regardless of it’s purpose, is part of your asset allocation.

    • Matt @ momanddadmoney June 16, 2013

      You are, of course, technically right that cash is part of your asset allocation, no matter how you think about it. But that’s not really the point here. The point here is about how you approach the decision of how to allocate your money.

      I don’t think about my cash in the same way that I think about my stocks. Stocks are set at a certain percent of my invested assets based on my desire for long-term growth and my capacity for risk. It makes sense to keep that at a stable percent, or a steadily changing percent, to match those desires.

      My cash is very different, as I explained here. I don’t need it to represent a specific percentage of my portfolio. I need a specific dollar amount, no matter what my total wealth happens to be. So it’s simply much easier to consider it in absolute dollar terms, separate from my invested money. Even though in the end of course it will represent a certain percent of my total allocation. It’s just that that percent will be dictated by how much money I have, and not by a steady proportion of the whole.

  • Roger Wohlner October 7, 2013

    I totally agree that short-term cash should not be part of an investor’s asset allocation. I never consider it as it is not an investment in my mind. In my opinion including this in one’s allocation will generally result in more risk than might be desired, all things being equal.

    • Matt @ momanddadmoney October 7, 2013

      I would think it would tend to put more at more risk than was healthy when they were younger (actually, when they had a smaller asset base) and would make them more conservative than necessary when older (with more assets). That is, unless you were constantly changing your allocation to account for the change in asset levels, which to me is just unnecessary complication. Much easier to keep a set amount of cash and leave your asset allocation to your true investments.

I’d love to hear from you, please leave a comment