This is a good question. I have been trying to figure it out for myself. I read a rule of thumb that indicated that one should have 3 - 5 years of cash. That seems like a bit too much to me.
I am working on a plan that partitions our money into 10 year (mini portfolios) for the decades of retirement. Whether they are actually seperate or not, I do not know yet... It may be just managed in a spreadsheet.
Plus, one other note on our approach is that we do not care about leaving a large estate behind. We plan to spend it.
When we reach 55 and FIRE, I will have alotted money for the decade of 55 - 65. We will manage that money to last during that period of time. I will start with a small pension that cover 10% of our needs. DW will begin SS @ 62... another income stream. That pool of money for 55 - 65 will be invested probably @ a higher amount of Bonds and a low amount of stock to reduce volitility. The cash account will hold probably 2 years of money to achieve our desired lifestyle, and 3 years of a minimum acceptable lifestyle. Those 10 years will probably consume 40 or 50% of the total portfolio.
The rest of the portfolio will be invested more aggressively for the subsequent decades. With a division of the total allocated to each decade. We are fairly sure that we will reduce our discretionary spending as we age, but we know that health care expenses could increase. We believe our spending will reduce dramatically after 75.
The way I look at it. I do not want to go broke, but I do not want to ride the volitility of the market to the degree that it interrupts our plans in retirement. That said, extreme things could occur where we might need to make adjustments.
As we age, if interest rates increase and an annuity looks attractive, we will consider purchasing one for the income stream. This purchase would only represent a small amount of our net worth, but it creates a bit of a safety net incase certain things go wrong... However, it is not a contingency plan that mitigates all problems that we may encounter.
All of the income streams that we pick up as we age will reduce the actual amount needed in the cash bucket needs to cover the income gap for that 2 year period. We may be able to allocate more assets to equity in the portfolio that is being consumed and not affect our lifestyle (i.e., capture a bit more growth).
In short... The amount of money in cash depends on the overall plan and how much belt tightening one is willing to do if the seas get choppy.