People do lots of stuff with their money. Spend it, of course. Pay for their rent and car and the occasional vacation to see the world’s largest burrito. Ideally, people also use some of their money to invest. The rest they keep on hand (to be clear, we’re talking saving or chequing accounts, not under mattresses) for immediate needs and emergencies.
But how much cash is the right amount of cash? Should you hold more when the market is falling, because it might fall more? What about when the market is hot and you’re convinced everything is overpriced? Is that when you want to rest your head on a pillow stuffed with hundreds?
The answer to every question but the first is typically no. Let’s dig in.
Why do people ❤️ cash?
Most people who are holding too much cash do so because they’re scared to invest. That’s perfectly understandable. Markets are volatile. They have rallies and dives, and it’s hard to know what will happen next — especially in the short term. We get it. But, historically speaking, it has almost always been smarter to invest.
When do you actually need cash?
Most experts say you should keep three to six months’ worth of living expenses in cash in case of an emergency. But when you find yourself with extra money outside of that emergency fund, the first thing to do is consider what it will be used for. If we’re talking about a short-term goal within the next 1-2 years, then it’s often better to keep that money in a savings account, preferably one earning as much interest as possible. But if you don't have an immediate need, investing that extra money in a diversified portfolio may be a wise choice.
Why is holding too much cash a bad idea?
A lot of people think that holding onto cash is eliminating the risk that you’ll lose money. But that’s not actually true. Thanks to inflation, the value of your savings is at risk of decreasing over time. Interest helps, but there have been many times where saving account rates can’t keep up with the rise in the cost of living.
Despite the ups and downs, markets generally trend upwards over the years. Think of it as the stock market doing its relentless march forward, powered by economic expansion, innovation, and corporate earnings growth. While it’s true that investing comes with its share of risks — markets can swing wildly in the short term — the longer you stay invested, the more you can flatten out those dips. Over time, market growth has consistently outpaced inflation, unlike the meager interest from savings accounts.
What do you do if you find yourself sitting on too much cash?
Don’t try to time the market. Even the pros don’t try to do that — it’s pretty much impossible. Instead, let’s talk about how to focus on what you have control over — your comfort level. There are a few ways to put your money to work.
1. Make a plan to get back in
If you’re ready, great. If you’re not and want to take a breather and wait for some sort of sign that’ll make you feel more comfortable, that can work, too. The key is to make a plan in advance and stick to it. That way you’re not stalling until the perfect moment hits. If it would help, you can choose a rally point you’re comfortable with — say, 5% up. Whatever you decide, stick to it, and know that it’s not a perfect system. Markets go up and down, and a small rally doesn’t mean the rollercoaster is over, so keep that in mind heading in. And know that, as long as markets have been around, they tend to go up over time (sounds familiar, right?).
2. Take the decision-making out
Automatic deposits take all the pressure off by automatically investing the same amount of money every month. You don’t have to worry about timing at all. This way, you get a variety of entry prices while ensuring that you’re consistently contributing to meet your savings goals — and completely removing emotion (and stress) from your decision making. This strategy is called dollar-cost averaging, meaning you invest a small amount on a regular schedule, regardless of the price of whatever asset you’re buying.
Does cash deserve its bad rap?
Kind of! Contrary to popular belief, cash can be considered one of the riskiest assets in the long run, since its real rate of return over the past century or so is somewhere close to 0.3%.
Sure, there have been rare times when cash has been the best performing asset class. It happened pretty recently, in 2022. Also in 2018, 1981, and 1973. But historically speaking, those circumstances haven’t tended to last very long.
No asset class tends to stay on top forever. Whatever’s the best performer now will most likely not stay that way. That’s why a mix is important: it helps insulate you from asset-, or geographic-, or industry-specific downturns, to ensure your portfolio stays strong in the long run. Diversification and time are fantastic ways to make sure your investments will pay off.
