Could your cash savings be harming you?

It’s hard to imagine having too much cash. But it is indeed possible to do so.

If you’re decades away from retirement and literally have more money than you know what to do with, it probably doesn’t matter if it’s all in cash somewhere. Most of us, however, have more financial goals than we have the money to achieve them – so we have to take the money we have and grow it over time.

Saving cash is important (especially for retirees), but it’s not the answer to growth wealth – that’s what millennials and Gen Xers really need to focus on. And this is where you can really have too much money in cash savings vehicles, whether it’s under your mattress, in a bank account or CD, or even a money market in an investment account.

There are several ways sitting on too much money in these different places can hurt you:

Money doesn’t grow on its own

Not only will inflation erode the power of your money, but by avoiding investments you are missing the opportunity to let compound returns create wealth for you. The cash in a bank account – or even in most CD or money market accounts – won’t increase enough to help most people reach their goals.

Most of us need to harness the power of financial markets to create and grow the kind of wealth we need to build the life we ​​want.

Money is not necessarily safer than investments

Some people want to store money because it makes them feel safer than risking their money in the market. And they are right: all investments do come with a certain degree of risk. Cash is generally considered an entirely safe place to keep money.

In other words, if you hide $100 in a safe at home or in your local bank and keep it there for 30 years, it will be worth much less tomorrow than it is today: your $100 will not will probably only buy $41 worth of goods. in 30 years (assuming an inflation rate of 3%). Compare that to what happens if you invest $100 for 30 years assuming a 7% return: you’ll have $761 at the end of those decades. Adjusted for inflation, you’ll probably be able to buy $314 worth of goods.

Sitting on silver could turn $100 into $41. Investing $100 without even contributing more to that initial contribution over time could leave you with $314. Which option seems “risky” now?

You may be tempted to time the market (and it’s not going to end well)

Many people sit on cash even in their investment accounts because making the decision to go into the market is emotionally overwhelming. And that’s only natural: you might not want to invest a lot of money in stocks and bonds all at once.

But the thing is, if you’re having this fear right now…you’ll probably always having that fear no matter what the market is doing on any given day. I have seen clients sit on the majority of their wealth for years. Every time I explain the dangers of keeping so much cash around, they say, “Well, the market can’t keep working. [whatever it’s doing at the time]. I want to wait until [whatever current event the news is saying is impacting markets at the time] blow on it.

So they wait. The market keeps going up, and the downside they were Of course was about to happen does not come. Then we have the same conversation six months or a year later, with the same results. Of course, the market will fall at some point. But in the meantime, you’re missing out on the growth that’s happening right now. There will always be something you can fill in those blanks with, no matter the day, month or year.

The solution? Use an investment strategy based on evidence, research and reasonable assumptions about what we know about efficient financial markets. And then realize that yes, the market will go down at some point, and that’s okay as long as you’re invested for the long term and to stay invested to overcome this volatility when it occurs.

Here’s how much money workers should keep in cash

At the bare minimum, you need enough cash to cover your regular, normal, and expected expenses. For most of us in our professional careers, that money comes from our earnings and our paychecks.

Beyond that, you also need money set aside for unexpected expenses. You can do this in two ways:

  1. Keep a cash cushion in your checking account. My wife and I keep a few thousand dollars in our checking account as a “buffer” that protects us against overspending and other small financial mistakes (like occasional expenses that we should have budgeted for but forgot about, or things like late charge). We act as if this buffer is our “$0 balance”. Every time we eat it, we immediately replenish it the following month by cutting back on discretionary expenses like restaurant meals or entertainment.
  2. Build an emergency fund. Our cash reserve in our checking account protects against small problems and budgeting errors, but our emergency fund serves as an emergency cash reserve if something serious unexpected or beyond our control occurs. We dove into this when we took our cat to the emergency vet a few years ago and racked up a $4,000 bill. This fund is intended true emergencies, and just not the money we can dip into when we want to buy something or take a trip “just because”. (We’re saving for these things instead.)

How many one cash buffer you keep in your checking account is a bit arbitrary, but you probably don’t need more than a few thousand dollars. If you’re keeping more than $5,000 as a buffer, you’d better put some of that money into a money market or investment account so it can get to work and generate a return on your behalf.

Emergency fund, on the other hand, come with more defined guidelines on “how much”. At a minimum, try to save three to six months of income in your emergency fund. If you experience greater income volatility or have a lot of financial responsibilities and obligations (or are simply more risk averse), you might consider saving six to twelve months of income for emergencies. Anything beyond that, again, would serve you better in a place where it can contribute to your efforts to build wealth.

Once you have these two cash reserves in place, you will also want to consider your short and medium term goals. Short-term goals are things you want to accomplish over the next few years; medium-term goals could be five to 10 years.

The money you need to meet your short-term goals should be kept fairly liquid or in a place with little or no risk that you can easily access at any time. Something like a regular savings account and potentially a money market account might work well. Medium-term goals are a bit more complicated; depending on the specific purpose, you may also want to keep this money in cash. Anything you need money for in five years or less probably has to be cash. Anything with a longer time horizon might be better invested in the market.

What workers can do with the rest of their wealth

Once you’ve set aside an appropriate amount of money for emergencies, reserves, and short-term goals, consider investing the rest if your goal is to grow your wealth. Depending on your particular situation and financial goals, “investing” can mean many different things.

Some options include:

  • Maximize your 401(k) or other retirement accounts (like a Roth IRA, SEP IRA, etc.). Just make sure these accounts are properly allocated and diversified based on your goals and risk tolerance. Remember that you can always hold too much money in investment accounts. You want to invest aggressively enough to give your money a chance to return in the market, but not in such a way that you can’t handle the volatility associated with increased risk or taking on unnecessary risks.
  • Consider investments outside of the stock market. You may want to start a business, buy a multi-family property to rent, or explore other ways to invest and grow your money – and whether that’s the right decision for you depends on your circumstances, needs, and of your specific goals.
  • Contribute to a taxable brokerage account. That’s what my wife and I are doing right now. We are both maximizing our SEP IRAs and our HSAs. We allocate $1,250 per month in a cash savings account because we anticipate needing to buy a car in the next few years and want to have cash on hand for that specific purpose. Then we pay the rest of the money we want to allocate to “savings” into our brokerage account.

This last point is especially important to think about if one of your goals is something like “financial freedom” or early retirement. Maximizing accounts like 401(k)s or SEPs is an important priority — but with few exceptions, it’s not easy to access that money before the official retirement age. And if you want the ability to stop working and living off your accumulated assets at age 50, you need to keep a percentage of those assets in non-retirement accounts.

The basics of money

Regardless of your specific view of the future, it’s generally a good idea to diversify not just your investment portfolio, but also the accounts you invest in – and hold more assets than a lot of cash.

Founder, Beyond Your Hammock

Eric Roberge, CFP®, is the founder of Beyond Your Hammock, a financial planning firm working in Boston, Massachusetts and virtually across the country. BYH specializes in helping professionals in their 30s and 40s use their money as a tool to enjoy life today while planning responsibly for tomorrow.Eric has been named one of Investopedia’s 100 Most Influential Financial Advisors since 2017 and is a member of Investment News’ 40 Under 40 class in 2016 and Think Advisor’s Luminaries class in 2021.