How much cash should I have on hand in my portfolio?

As you build and maintain your portfolio over the years, you probably want to know how much of it should be liquid in cash or cash-like investments you can access quickly—holdings like savings, checking and money market accounts and short-term investments.

The answer isn't a simple formula or percentage and instead depends on several factors. Your liquid cash and long-term assets should work together to create a portfolio that's ideal for you and your goals. This mix may change based on the favorability of the economy, on how close you are to reaching your goals and on your comfort level.

Let's dig into those factors and other considerations for allocating your percentage of liquid cash as well as the risks of holding too much cash. Understanding what influences your portfolio's holdings can help you find the right answer for you.

It's generally best to hold enough liquid cash assets across all your financial holdings so you could cover between two and five years' worth of planned expenses if needed. Ideally, your available cash would mirror what you need for your planned near-term expenses and goals as well as an emergency fund for unexpected costs like car or home repairs.

The remainder of your portfolio should remain invested in assets for the medium and long term, such as bonds, stocks, equity ETFs and mutual funds.

Your retirement savings needs its own split between liquid and other assets because you'll be depending on it for lifetime income. When you're younger, you can tip the balance in favor of less-liquid, more aggressive longer-term investments. As you near retirement, though, strive to move enough into cash reserves, more conservative stable investments, and not count on potentially volatile investments for spending needs.

Once you are dependent on these dollars as income, it is generally advised to have easy-to-access sources to provide two to five years' worth of retirement income beyond what's covered by fixed income sources like Social Security and pensions. The reasoning behind this advice is that, historically, bear markets tend to recover in a few years, so you can spend from your cash while waiting for your long-term investment portfolio to recover from any downturns rather than selling investments at a loss.

Three key economic conditions can influence the amount of cash reserves you want to have: market volatility, interest rates and inflation. At times, it may be to your advantage to have closer to two years of expenses in cash at some times and closer to five years at other times. Here's what to consider:

When the stock market experiences large fluctuations over a short time (weeks or months), it can tempt you to move your investments to liquid cash immediately. Rather than emotional investing, however, base decisions about your cash reserves on your time horizon. If your financial goal is near, shifting to liquid assets may be a wise move—you don't want to risk your money not having time to recover from big losses. But if your goal is far off, you may be better off waiting for the market to inevitably self-regulate.

Holding enough cash to weather market fluctuations can provide a safety net, giving you the flexibility to make the best decision for your goals.

Depending on what interest rates are, holding large amounts of cash investments can give your portfolio some stability, or it can limit its growth potential.

When interest rates are high on liquid investments—such as CDs, money market accounts and bonds—it can make sense to park more money in them. If you're planning on spending the cash soon, you likely won't miss out much on potential gains from less-liquid investments like stocks and mutual funds. Plus, if the market feels too volatile for you, bulking up your cash reserves balance can give you a more conservative investment allocation. Your cash holdings can be a cushion that balances losses elsewhere.

However, if interest rates are low, you may want to store just the minimum amount of cash you need to cover your near-term spending and explore other growth opportunities.

When inflation is high, your cash investments may not gain enough earnings to maintain their value. If you hold cash in high-inflation conditions for a long time, your purchasing power can decrease. Let's say, for example, you put $20 in a savings account with 1% annual interest 10 years ago. Over the same 10 years, the inflation rate was 3% per year. Even with compound interest, your $20 effectively lost value because inflation outpaced your savings growth.

But cash reserves also can help mitigate the impact of inflation when the conditions are right. If cash investments are paying out at a higher rate than the inflation rate and your goal is coming up soon, it can be a smart move to increase your portfolio's liquid cash percentage.

Here are a few situations to illustrate how these factors could come together to influence your decision about how much liquid cash to hold.

Start your evaluation with your goal in mind. Let's say your teenager is headed to college next year, and you want to pay for their education. The market's been volatile. Inflation spiked and then cooled, but interest rates on cash-like assets are high at the moment. Cash reserves would allow you to cover that cost without putting strain on your long-term investments.

In this case, you'd likely want more liquid cash in your portfolio both because economic conditions are favorable and because you're close to needing to tap into your money. You'll likely want to have stable, liquid investments this close to college time because in the market, your money may not have time to recover from big losses that could occur before tuition is due.

Let's say another financial goal of yours is saving to buy vacation property about 20 years from now. The part of your portfolio dedicated to that goal generally can stay less liquid based on the longer time horizon. However, assume again that markets are volatile, inflation has fallen following a peak, and interest rates are high. You may be tempted to shift more investments to cash-like options. Cash reserves can provide stability, but it's important to balance them with long-term investments to maximize growth potential. If you make this decision for your far-off future based on short-term economic conditions, you may lose out in the end.

Staying the course with investments designed for the long-term ups and downs of the market may be better than limiting your holdings to cash. That's because long-run returns on more volatile assets tend to be better than the interest you can earn on cash. For example, the historical average return of the S&P 500 is a little over 10%.

Holding too much cash can create a drag on your returns and expose your savings to the uncertainty of interest rate fluctuations. If you hold a lot of cash, you could exceed the federally protected limit, exposing you to risk in the event of a bank failure.

Even though cash investments can provide stability and a sense of security, you need to be aware of how these drawbacks may affect you:

• Regardless of how high interest rates are, liquid cash investments are not likely to perform as well as other investments over a long time. Most people need some of the growth that equity investments can provide to reach their savings goals or ensure their portfolio lasts throughout retirement.
• Interest rates change continuously. If you hold a large cash balance and interest rates drop, your savings will not pay as much as they might have earned elsewhere.
• Certain cash holdings with banks, such as CDs and high-yield savings accounts, come with FDIC insurance protection. This can provide some assurance your money isn't at risk, but the FDIC limits coverage to $250,000 per person, per account type, per institution. If your cash balance is too large, it may not be fully covered.