Is cash still King?

Personally, I love holding cash. I love seeing the balance of my bank account grow.

There’s a feeling of safety with cash. A feeling of knowing you can handle any problem that’s thrown your way.

Cash is simple to understand. You get paid, and what you don’t spend, accumulates in your bank account. You earn interest once a month and the balance compounds over time.

However despite how much I like seeing the cash accumulate, there are several inherent flaws with cash as an investment option.

First of all, it doesn’t provide capital growth.

Would you invest in an asset that doesn’t grow in value over the long term?

I know if I invested in a stock that didn’t increase in value, I’d be outraged!

Yet people hold mountains of cash not realising this is effectively what they have done.

Second of all, the returns on cash in terms of yield are currently abysmal. 2% interest is nothing to get excited about (and that’s probably exaggerated these days).

However the real problem with cash is that it doesn’t keep up with inflation.

Inflation is generally defined as the general increase in the price of goods and services over time. Inflation is when your parents say they use to buy a bag full of lollies for 20cents, but it now costs you $5. This means that as time goes by, the value of your cash actually decreases in real terms.

If you hid $100,000 away now under your bed and didn’t do a thing with it for 30 years, that $100,000 would be worth much less in 30 years time as the value of goods and services will have grown exponentially. Essentially, the longer you hold your cash, the less you can buy in the future.

For most people, the problem is magnified even more because the interest earned on savings are taxed. So even if your money was keeping up with inflation, it will almost certainly fall behind inflation once tax is taken into consideration.

Despite this flaw which makes investing in cash over the long term less desirable, cash can still be used effectively in the following circumstances:

• When you are saving for a short-medium term goal. As other investments such as shares, property and managed funds are volatile, they typically aren’t the best place to invest money you need within the next 5-7 years.
  

• Given the volatility of other investments, cash can be a great resource for those requiring certainty with their personal finances. Think of a retired couple that are drawing down on capital for living expenses. If the value of their shares halved over night, this could be catastrophic for their retirement. Therefore, having 3 years worth of expected expenses in cash would, on the balance of probability, provide them with income security and help them sleep a little easier at night.
  

• To take advantage of upcoming share market crashes. Say you were of the opinion the share market were to crash, cash is a great place to store your wealth and take advantage of investing opportunities. In the event of a crash, your cash might go twice as far.
  

• Cash is also worthwhile when you have investments that are cash intensive. Think businesses with employees that need to be paid every month, investors with negatively geared property. Cash compliments these investment choices by taking some of the risk out of operating these cash intensive investment vehicles.

So how much cash should you hold?

Well, it really depends on where you are in life.

Some rule of thumbs are:

• You should definitely hold enough cash to cover unforeseen emergencies and bills. And you should definitely hold enough cash to cover your living expenses without having to use a credit card to tide you over until your next pay cheque.
  

• If you’re retired or approaching retirement, I’d recommend holding at least 3 years of estimated expenses in cash. You never know what will happen and in most cases, the retired need to protect their capital and can’t be fully exposed to the volatility of the share market. If however you are accumulating wealth and not retiring anytime soon, I’d recommend 3-6 months cash put aside before investing.
  

• If you’re young and working and not saving for a house, you probably don’t need to keep much cash at all and should be thinking about investing most of your savings.
  

• Hold an amount of cash that makes you feel in control of your finances, an amount of cash that makes you feel powerful. By powerful, I don’t mean world dominating, but enough that you are feel flexible to live your life on your terms, to take risks, to explore side hustles and make sideways steps in your career.

Me personally - I hold at least 6 months worth of expenses in cash.

Why?

Because that’s where I feel comfortable and it really does help me pass the sleep at night test.