It may sound counterintuitive, but it’s not considered a good idea to stash too much cash in your chequing or savings account. In fact, it’s generally unwise to have too much cash (or equivalents) in your portfolio, period.
That’s not to suggest you should avoid accumulating money. Far from it. Rather, the point is to avoid keeping that money as cash (or cash investments, such as GICs), instead of finding more effective ways to make it work for you.
So, how much cash is the right amount to keep in savings? Like many financial questions, the answer depends on individual circumstances. Here are the key questions and concerns when it comes to cash.
What’s the problem with keeping too much cash?
Whether you put your cash in a high-interest savings account, a GIC, or just stuff it under the mattress, you can’t escape an unfortunate truth: inflation. Even when it’s not running wild the way it has in recent months, inflation tends to be higher and rise more quickly than interest rates. What that means is the purchasing power of your cash savings always erodes over time. An item that costs $20 today could cost $25 in a year or two, meaning the money you’ve stashed away doesn’t go as far as it did when you earned it.
Cash isn’t as safe a haven as it’s often made out to be
Cautious investors may choose to keep a high amount of cash and cash investments in their portfolio, viewing it as a safer strategy than exposing their nest egg to market dips and declines. While it’s true that such a strategy helps preserve capital, an unfortunate consequence is that it can also limit gains.
In the short term, stock markets can always go down and investments can lose value. Historically, however, annual market returns have outpaced the best available interest rates on savings accounts or cash investments, meaning anyone not invested in equities is losing out on earnings.
How much of my portfolio should be kept as cash and cash equivalents?
There’s no hard and fast figure for this one. For some, especially older or more wealthy savers, the ideal amount of cash in a portfolio should be as high as 30 to 35 per cent. For others, as little as five to 10 per cent is fine. Personal circumstances such as age and size of portfolio will impact your choice here, but 20 per cent is a decent rule of thumb.
What benefits are there to keeping spare cash in my savings accounts?
If markets are in broad decline, or you just don’t see any suitably attractive buying opportunities out there, you might choose to build up extra cash reserves in a savings account. The idea is to put yourself in a position to act fast and buy big when the right opportunity comes along, whether that’s a deeply discounted stock, a real estate purchase, or something else that will earn more than cash savings can.
Likewise, a little extra cash can provide a way to pay for expenses without having to liquidate investment assets, potentially locking in losses by having to sell at inopportune times.
Do you have enough cash to cover living expenses in case of an emergency?
As we’ve mentioned in past blogs, financial experts commonly agree on the importance of building an emergency fund, a stockpile of cash you can turn to in case of job loss, health problems, or other unforeseen circumstances. The goal is to save three to six months’ worth of income, or enough to cover all your expected costs for the same period.
If you’ve met your emergency fund goal, you can feel confident diverting more cash into other, higher-earning investments. If not, keep putting cash aside for now.
Do you know when you might need money?
Emergency expenses tend to be unpredictable, but some costs come with advance warnings. You probably know beforehand when you might need to buy a new vehicle, or pay for repairs to your home. If there’s an obvious expense on your horizon, consider keeping cash in a high-interest savings accounts to cover the cost, or as much of it as you can. That way, you’ll be able to reduce borrowing costs for loans and lines of credit.
Likewise, if you’re less than 10 years away from retirement and want to insulate your investments against decline, it’s okay to start drawing down your exposure to the stock market and increasing the amount of cash in your portfolio, helping preserve your capital for the time it’s most needed.