How much cash is too much cash?

With the stock market at highs, there is a very strong temptation to keep cash “on the sidelines” for the right time to invest. I believe, in the long run, investing now is better than investing later.

The massive risk of waiting on the sidelines is that you never get off the sidelines.

And when you don’t, your cash suffers.

Inflation erodes purchasing power

Inflation is always eating away at your purchasing power.

Every year, the amount you can buy with a dollar gets less and less. Inflation is also uneven, hitting some areas more so than others.

And we’ve felt it very acutely the last few years, especially at the supermarket and at the gas pump.

Putting cash in a high yield savings account can limit some of the damage. You get 3-4% interest, pay income taxes on it, and are left with an amount that, in normal years, is probably slightly below the expected rate of inflation.

High yield savings accounts, and other inflation pegged instruments like TIPS, only slows the erosion. That’s the cost of liquidity.

That’s acceptable for emergency funds and short term goals, where you want that liquidity. It’s unacceptable for cash you won’t use for decades.

And if you need to put money in a safe place, consider inflation pegged instruments like TIPS or at the very least get a certificate of deposit. I like checking CD Valet for the best rates since they aggregate them from thousands of banks. Don’t let it languish in cash!

Productive assets often beat inflation

The appeal of investing is that by taking on additional risk with productive assets, you get the opportunity get returns that exceed inflation.

The stock market is volatile, so in the short term it may go up or down, but in the long run it crushes inflation. And that’s the point.

When you don’t invest your cash, you lose out on a lot of gains. The opportunity cost is enormous.

$100,000 appreciating at 7% a year will double in a little over 10 years. It does nothing if it remains as cash.

Cash is tempting to spend

This will depend on your temperament and how your finances are structured, but some find a big slug of cash sitting in an account to be dangerous. It’s just very tempting to spend it.

If it isn’t already earmarked for something, life has a funny way of whittling away at large balances.

If this describes you, it’s even more important for you to put that money to work because otherwise it will leak.

Forever sitting on the sidelines

For those folks who believe they simply sitting on the sidelines and waiting for a “good opportunity,” that’s laudable but how often does that waiting last far longer than you expect?

One week becomes one month becomes one year or more. And if you miss

Timing in the market beats timing the market. When you sit on the sidelines, you risk sitting far longer than you should have.

If you missed the five best days in the S&P 500 over the last ten years (five total days, not five each year), your returns would have suffered incredibly.

• When fully invested, $100,000 becomes $~417,000 for a total return of ~317%.
• When missed 5 best days, $100,000 only becomes ~$286,000 for a total return of ~186%.

By missing just five days, you are $131,000 poorer. A ~31% difference.

How much cash do I need?

There is no universal answer because we’re all different but guidelines can be helpful.

If you have a stable job, you may need less cash on hand than someone who is in sales and gets paid more in commission.

Start by understanding how much you may need in an emergency fund. This post gives you an idea of how much you need in an emergency fund. I think 6 months of expenses is a minimum, twelve months if you want to be extra safe or are in a very tenuous job situation.

Then ladder that money into certificates of deposit to maximize your interest. Again, CD Valet is good for that.

From there, you can think about your savings goals and decide where to put those savings based on the time horizon. How you treat savings for college in ten years will be different than a vacation next summer. The vacation next summer can be in cash or CDs but long-term savings should be in the market until you’re within five years of needing it.

Finally, you need to sleep well at night. If that means you need a large cash cushion or you’ll be a nervous wreck, fine, do it. Keep more cash.

Just know what you’re leaving on the table.