Holding cash vs. investing your money: a balanced financial portfolio includes both cash and investments. But deciding what percentage of your total funds to keep liquid (meaning that they are easily converted to cash) and what percent to invest in non-liquid investments (which are more difficult to convert to cash) can be tricky.
On one hand, you want some of your money to be accessible in case you need it. And, on the other hand, you want some of your money to be largely inaccessible because these low-liquidity assets often provide the highest returns.
Macroeconomic trends can increase the pressure to lean more heavily toward cash or investments. For example, when financial markets are uncertain, it’s tempting to hold more cash. And when inflation is high, it’s tempting to move your cash and cash equivalents into investments so that you don’t lose purchasing power over time.
In this article, we’re going to answer all your cash vs. investment questions, including:
● How does holding cash compare to short-term investments?
● How does holding cash compare to long-term investments?
● When should I keep cash on hand?
● How much should I keep in cash vs. investments?
Holding Cash vs. Short-Term Investments
Many investors mistakenly believe that they should hold all short-term funds in cash. With this theory, any money that could be needed within the next year or two (for a planned vacation or a move, for example) should be held in cash or cash equivalents (like savings accounts or money market accounts). But this is incorrect.
There are many situations in which it makes more sense to put your capital in short-term investments rather than cash. Let’s compare the pros and cons of holding cash vs. short-term investing.
Pros and Cons of Holding Cash Short-Term
The benefit of holding cash is that your money is always available. If an unexpected expense comes up, for example, you will have the funds available to cover the expenses. You won’t have to use a credit card or personal loan for the expense, both of which come with high interest rates that can end up costing you more than the expense itself.
Having cash accessible also allows you to take advantage of unexpected investment opportunities that arise. If allyour cash is already tied up in investments, you don’t have any money available to invest in whatever new, exciting opportunity comes along.
The downside to holding cash short-term is that your money isn’t able to grow. If you hide some money under the mattress, for example, it will not earn any interest or grow in value.
Pros and Cons of Short-Term Investments
The primary benefit of investing for the short term is that your money is working for you. The yields generated from your investments can help you reach your savings goal sooner. This is even more important during periods of high inflation when you need to invest to avoid losing purchasing power.
The downside of investing for the short term is the greater risk from market volatility. While investments in the stock market typically grow over time, the day-to-day increases and decreases can disrupt your short-term investment capital. Imagine, for example, that you’re saving for a European vacation, which you’ll need to book (and pay for) one year from now. If you invest in the stock market, you run the risk that the market will be down in “bear market” territory the week you need your funds to book your trip, and your portfolio will be worth less than your original investment.
Over the long term, investments have a clear advantage over holding cash.
Pros and Cons of Holding Cash Long-Term
Holding cash over the long term provides little benefit because your cash can’t grow. If your cash is sitting in a safe, for example, it’s not able to grow. In fact, because of inflation, that money actually has less buying power year after year. Imagine that you stashed $100,000 in a safe in 1985. At that time, that amount could have purchased a comfortable home. Now, it might only cover a 20% down payment on a home.
Purposely holding cash long-term does more harm than good.
Pros and Cons of Long-Term Investments
Conversely, when you invest for the long term, you enjoy impressive benefits like
Passive income. Assets held for the long term can generate income in the form of dividends or rental income.
Tax benefits (depending on your asset classes). You can grow your wealth faster through several types of tax benefits in real estate investing, for example.
A hedge against inflation. When your investment returns outpace inflation, your wealth is continuously growing and increasing your purchasing power.
With long-term investments, you have time on your side! By investing early, you can take advantage of compound interest, which will grow your wealth over time with very little effort on your part.
Long-Term Investments to Consider
Long-term investing offers greater flexibility than short-term investing because you have the luxury of choosing investments with lower liquidity and potentially higher yields. Since you don’t need the funds to be available in the near future, you can take advantage of dollar cost averaging, for example. This is when you regularly purchase a set dollar value of shares of a company, mutual fund, or index fund (like the S&P 500) regardless of the stock price on the date of purchase. Over the long term, market fluctuations will average out your per-share price. This is a common practice for investing with retirement accounts as you invest a percentage of your income in the market each month.
Real estate is another classic long-term investment vehicle. It’s hard for other investment types to compete with the high returns and passive income potential of investing in rental properties.
When You Should Definitely Save Cash
Having some cash on hand is a crucial part of sound financial planning. When faced with unexpected expenses, it’s better to have the cash available than to use a credit card or personal loan to cover the costs. Credit cards and personal loans come with high interest rates that can end up costing more than the expense itself.
A good rule of thumb is to keep around six months' worth of living expenses in cash or cash equivalents (but you can go as low as three months or as high as 12 months, depending on your personal risk tolerance level). The idea behind this six-month rule is that the amount should be large enough to cover most unexpected expenses, like a vehicle repair or a new air conditioner. Six months of living expenses also buys you time in case of a job loss. You’ll know that you have enough cash available to live on while you find a new job.
These “emergency fund” savings should be kept in a high-yield savings account or money market account, both of which are cash equivalents. Both options offer higher returns than a standard checking or savings account. But neither will offer yields on par with other investment types. This is why it’s important to put the rest of your savings to work in various short-term and long-term investments.
How Much You Should Keep in Cash vs. Investments
There is no set ratio or dollar amount to keep in cash vs. investments; once your emergency savings account is fully funded with 3-12 months of living expenses, the rest of your money should be invested.
The investment type will depend on how soon you plan to use that money. If you plan to need it in under two years, consider short-term investment options. You can use mid-range investment options, like REITs, for funds that you’ll likely need 2-5 years from now. And for funds that you won’t need in the next five years, you can invest in the long-term investment options we’ve mentioned or any number of alternative investments.
Invest Excess Cash in Real Estate with Gatsby Investment
With so many investment options for your excess cash, deciding which investments to choose can be overwhelming. At Gatsby Investment, we’re here to make investing easy!
We specialize in real estate syndication, which makes unique, high-value real estate deals accessible to everyday investors. We pool funds from multiple investors to keep investment minimums low. Our experienced team will manage every aspect of your investment, providing regular updates through our transparent investor dashboard. And with our established systems, we can maximize returns while minimizing risks.
We offer investment options for every timeframe, including
