Are the recent news reports of all-time stock market highs keeping your money on the sidelines? When you peek at your bank account and see your hard earned money stacking up in your savings, it feels good, right?
But, could keeping those extra Benjamins in your account be costing you money in the long-run? The answer is yes. When your cash is sitting on the sidelines, you are not making the most of your investment opportunities. Putting your idle cash in play can significantly increase your portfolio returns and overall wealth.
How Does Idle Cash Build Up?
Idle cash can build up in multiple ways. At the moment, one of the biggest reasons is simply nervous investors scared of “buying at the peak.” As we continue to get inundated with reports of “New All-time High for the S&P 500” (variations of these titles make wonderful clickbait) it stokes our fear of buying near the top. Actually, the real fear is buying high and then watching our hard earned money lose value soon after because it just “feels” like the market is due for a correction. The result is cash continues to build as investors wait for that “perfect time” to buy on a dip (*hint: a number behavioral biases and the way our brains are wired will trip you up).
Another way cash builds up is not knowing what to do with it. This is basically an extension of the first point. Young professionals earning more money than they are used to can let cash pile up in their savings because they don’t know how to make it work for them. At the other end of the spectrum, experienced investors may not even realize they have idle cash building up if dividend payouts from their investments aren’t automatically reinvested. Cash from passive revenue streams, such as rental properties, may not be integrated into your investment portfolio and is actively dragging down your return potential.
Whichever scenario describes you, having too much idle cash in your portfolio is not a smart financial move. But how much cash is too much? No one wants one wants to be without money in an emergency, so it is advisable to have at least 3-6 months worth of funds readily available. Other than your emergency fund, you should explore ways to limit the amount of cash in your overall portfolio.
Know How Much Cash You Have
According to the CFA Institute, portfolios of actively managed funds typically carry a cash position of about 5%, causing the funds to lose a portion of the long-term equity premium. Do you know how much idle cash you are carrying? Evaluate your portfolio quickly, because the excess cash sitting in your savings is losing the fight to inflation.
Think about it, the value and purchasing power of $100 is very different today than it was 30 years ago (I actually muttered these words on a recent ski trip with my kids “Ya know, I remember when ski lift tickets were less than $30!”, which makes me officially “old”). Holding on to cash in the long-term, without earning interest on it, is like throwing it away. The extra cash in your portfolio can be reinvested in a variety of ways in order to have your cash make money for you in the long-run.
Make Your Cash Work For You
Here at Pathway, we can help you determine the best way to put your money to work that is aligned with your current needs and goals for the future. The key is to think long-term. What are your goals? Are you going to retire soon or are you just beginning to save for your first home? Ask yourself if your short-term needs can be met without access to your extra cash. The answers to these questions shape and direct your cash investment strategies.
Cash in your checking or savings account yields little to no interest, so investing in short-term securities–such as short-term, high-quality bond funds–is a smart move if you need annual access to cash. These type of investments are stable and can be liquidated in a matter of days, but earn more returns than money collecting dust in your savings account.
Stocks, riskier longer-term bonds, municipal bonds, and real estate are all excellent long-term investment options if you are in a position to limit access to your funds for an extended period of time (we recommend at least 10 years for these kind of investments). Investments such as these take commitment, but can be lucrative if held for a decade or more.
How We Can Help
If you think you are carrying excess cash in your portfolio, we can help. We offer a free portfolio analysis that will show how much of your long-term returns, historically, have been hurt by too much cash. We have a unique way of doing this analysis without sending any paper back and forth, and only takes you a few minutes–we do all the heavy lifting!
Interested to learn more? Book a quick “Office Hours” session with us and we’ll let you know how to get started.
For many people, a 401k is their largest retirement account. It deserves your undivided attention. Download our Ultimate 401(k) Guide for a step-by-step strategy to master your 401(k), including a prioritized checklist. It’s free!
Pathway founder and principal Greg Brown is a fee only financial advisor with broad financial planning and investing expertise. Greg’s financial advice has been featured in publications like Yahoo Finance, Bankrate, Investopedia (all articles here), Wall Street Journal, and USA Today. He holds a master’s degree from the University of Chicago and a mechanical engineering degree from Michigan State University. Prior to Pathway, Greg was a lead analyst at Morningstar and previously held engineering roles at Dell (including a US Patent).
Also published on Medium.