Your investments should always be working for you. When you invest your money in asset classes like stocks, bonds, or real estate, you set an expectation of the amount each should earn over a given time. And although cash is considered an asset class, it is not a good investment because it is not actually working for you. Instead, it is sitting idle and working for the bank or custodian that holds your cash, and over time, inflation erodes the purchasing power of cash, meaning that what you can buy today with a dollar will likely cost more in the future. By investing in things that yield income and appreciation, you better shield your wealth against inflation’s erosive effects and unlock its potential to work in your favor.
Determining the optimal amount to hold in cash investments involves a thoughtful analysis of expected returns across various asset classes over time. Consequently, our expectations for returns follow a hierarchy: we anticipate higher returns from bonds compared to cash, and even greater returns from stocks than from bonds. Given this understanding, we should hold the minimum necessary amount in cash. This usually equates to covering upcoming expenses, with some potentially needing up to six months’ worth. However, it’s crucial to distinguish between needing a lot of cash versus having access to cash. Many individuals overestimate their need for cash when, in reality, they have access to liquidity through various means such as investment accounts or home equity lines of credit.
Retirees often inquire about holding more cash, perhaps to shield funds earmarked for the next five years from market volatility. While it may seem prudent, retirees should not overcommit to cash holdings. A well-structured portfolio generates income from various sources, including bond yields, real estate distributions, and dividends from stocks. Additionally, other income streams such as rental properties or retirement benefits contribute to financial stability. Bonds, with their higher expected returns compared to cash, serve as a suitable option for covering expenses beyond the immediate future.
