Because the markets are inherently volatile, it may make sense to create a spending reserve to cover your living expenses. A spending reserve is created by liquidating a portion of your assets and investing them in short-term holdings such as money market funds, Treasury Bills, and Certificates of Deposits (CDs).

The size of your spending reserve should depend on, among other things, how frequently you expect to take withdrawals from your assets, the amount you need to withdraw, the volatility of your assets outside the spending reserve, and the amount of time you want to spend determining which investments to liquidate. For example, if most of your holdings are not too volatile or you only need to withdraw a small amount, you may want to create a spending reserve for only one to three months. If on the other hand, your other investments are fairly volatile or you need to withdraw a large amount, you may prefer to create a twelve-month spending reserve so you don't have to worry as much about the daily fluctuations. (Note that your spending reserve is in addition to your emergency fund.)

The amount of the spending reserve you establish will largely depend on your lifestyle and other personal preferences. Using a 12-month time frame does, however, pose certain advantages. For example, it may reduce the overall amount of time spent per year on the task, as well as help minimize commissions and other transaction costs associated with liquidating securities. An annual cycle can also be timed to occur at year-end to coincide with tax planning and an annual portfolio review. Perhaps most important, a yearly cycle may reduce the temptation to time trades or market cycles.

Regardless of the amount of spending reserve you choose to set up, setting aside a portion of your assets in both spending and emergency reserves will help assure that you can meet your immediate expense needs without concern for short-term market volatility.