But Kings Don’t Always Rule

We’ve all heard the age-old adage that “cash is king.” I’ve used it myself countless times. It’s one of those phrases that can be used to fit different situations and can be used very differently by people with varying interpretations of its meaning. Those of us in the investment business talk so often about asset classes such as stocks, bonds and real estate, but it’s not often that we talk about cash. (And it should be noted that when we refer to cash, we are referring to cash in the bank, not simply paper money under the mattress!)

Cash serves an important purpose. It can be good, and it can be bad.

So, from a financial planning standpoint, when is cash good? When is cash truly king? I suggest two primary times:
1. Emergency/Liquid Savings
Everyone should have some easily accessible (liquid) savings.

We often refer to this as emergency savings, but in truth it’s more like practical real-life savings. If you plan, there’s absolutely no reason why most expenses should take you into debt. In other words, if your answer to a sudden vehicle or home repair is that you can put it on your credit card or home equity line, then in my opinion you’re thinking about your finances in an unproductive way. This is the portion of your assets that should be in cash—not in investments.

For most people, this amount is a minimum of six months of living expenses.

2. Expenses/Purchases in the Near-Term
Is your child starting college in the fall? Is your vacation just around the corner? Have you planned those summer yard projects? These are all expenses that you already know will be happening soon. What asset class is best for these? Cash. There’s no need in a) tying up money for these expenses in illiquid investments or b) risking market fluctuations by having money for these expenses in potentially volatile investments. Might you lose some potential interest or appreciation? Sure.

Might you also save yourself from a cash shortfall by having this money in cash-on-hand? Absolutely. Cash is great and arguably necessary for near-term expenses that you know are on the horizon.

So, for your savings account and near-term purchases, cash truly is king.

In modern times, however, kings have very little real power. Not only can kings be powerless, but they can also be quite harmful. Without taking the analogy even further past its useful purpose, I’d like to posit that cash in your investment portfolio can sometimes be harmful to your financial health and wellbeing. When might that be?

1. Long-Term Retirement Savings
For anyone not already in or nearly approaching retirement, there are usually more productive uses of your retirement savings than cash. Why? Because cash loses value. We know that the return on cash is a flat out guaranteed 0.00%. If you’re lucky, in today’s rate environment, you might be able to increase that slightly. The problem this poses is that items we purchase get more expensive over time. How much more is your health insurance this year than last year, for example?

This inflation means that money sitting in cash earning 0.00% is losing purchasing power by the day! Why do that to yourself? “But,” you argue, “the market could crash!” Yes, but let’s not forget that equities aren’t the only alternative to cash. What about short-term bonds and CDs?

What about Treasury Inflation Protected Securities (TIPS), as an example? Some of these investments can provide modestly higher returns than cash. In the case of FDIC-insured CDs and U.S. Treasury instruments there’s very little added risk. I’m amazed how often I see large percentages of people’s retirement savings in cash—sometimes 100%. Unless you’re on the cusp of retirement or stuck in a workplace retirement plan with no safe alternative options, I would argue you’re truly doing yourself a disservice.

2. Trading Accounts/Market Timing
You’re waiting until “things get better” to put your cash to work.

Or maybe you’re trying to “buy the dip.” Do you know exactly when that will be? Neither do I. Study after study shows that average investors and investment professionals alike are unbelievably bad at timing the market. People who spend every waking hour trying to accomplish this often have very little success. Don’t fool yourself into thinking this is a productive way to invest. Keep cash for what it’s needed for, but not as an investment or market-timing strategy. If you’re concerned about volatility, then seek less-volatile investments.

Take Aways:
Cash is best for emergency savings and known near-term expenses. Too little cash set aside for these purposes can be harmful to your financial well-being.

Cash is not an investment and should not have a prominent place in your long-term investment portfolio(s). Too much cash set aside for this purpose can also be harmful to your financial wellbeing.

Know the purpose of your money, including your cash. This can help you make sure that you don’t have too little or too much stored in the “king” of asset classes.

Disclaimer: This article is generalized in nature and should not be considered personalized financial, legal, or tax advice. All information and ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

By John N. Hall