I’m a huge believer in holding cash – in bank accounts and investment accounts. It’s rare when my investment accounts don’t hold at least 10% cash and I like to hold at least 6 months worth of cash expenses in a savings account. Interest rates in savings accounts and CDs has been essentially zero for five years and it’s starting to get people to really question the value of cash. MarketWatch had an article out today suggesting people might be better off investing their emergency savings in a mix of stocks and bonds instead of keeping it in a bank account. I completely disagree with this argument.
I believe in the concept of capital preservation first, then capital growth second. I also believe that liquidity is very valuable, financially and emotionally. Text book financial theory will tell you that cash is a drag on returns in your portfolio. The argument is, over time, stocks, bond, real estate, etc should appreciate at a higher rate, therefore, being fully invested at all times is the prudent decision. That reminds me of the old saying, “In theory, there is no difference between theory and practice. But, in practice, there is.” Investments go up until they don’t. National real estates could never drop until they did. Cash will always underperform is a rising market, but cash is a great place to be in down markets. Holding cash can also allow you to act when prices drop while others are suffering large losses. Most importantly, cash gives you the freedom to handle a job loss, a reduction in pay, an illness, etc.
When people start talking about investing cash savings, it really shows how short memories are. The S&P 500 declined over 60% from peak to trough between 2007-2009. While the market has recovered and gone on to new all-time highs, how many people sold around the trough and suffered the losses, without all the subsequent recovery?
If you need the money in the next few years or are over 50, then the value of cash can’t be overstated. You don’t have time to recover from a large loss in the stock or real estate market. The best way to accumulate wealth over time is to 1) do everything you can to maximize income, 2) spend 10-20% less than your take-home pay and 3) take a prudent, long-term view of investing. In my mind, #3 includes holding a sizable cash position to provide financial flexibility and peace of mind.
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