By Ted Stricker, CFP®
It’s a common axiom in personal finance to keep sufficient cash on hand for emergencies or as a safety net for unforeseen financial difficulties. Having cash in the bank is still akin to a warm blanket on a cold winter’s night; there is a sense of security that comes with knowing that come what may, cold hard cash is still king in times of trouble.
Believe it or not, however, there are risks to holding cash too, and these may be hidden (or stealth) risks that may not be readily apparent, but can aid in eroding your wealth (or assist in the failure to grow it) over a period of time.
One of the core tenets at Bernath + Rosenberg is that the various facets of one’s finances should be organized and coordinated to work seamlessly together toward stated objectives, both near-term and longer-term. This also means that one’s wealth should be working as hard as prudently possible, given each aspect’s time horizon and purpose. Cash as an asset may be desirable for certain reasons, but the risks of holding cash should be understood and fit within the context of your overall financial plan and journey.
Let’s take a look at how and why cash is held, the hidden risks of doing so, and ways to find a reasonable balance to offset those risks.
Reasons to Hold Cash (and How Much Is Enough?)
Cash is a liquid asset and should remain as such for certain purposes. These include:
- Working cash: This is your checking account balance with which you pay your monthly bills. Depending upon your income situation and its consistency, you might keep at least two months’ worth of expenses in your checking account. You might also have an interest-bearing checking account if your balance meets bank criteria.
- Cash savings account: This is your emergency fund, the balance of what you’d need if something unexpected occurs. How much depends upon many personal factors: job stability, lifestyle, financial responsibilities, and personal preference. You might also keep a separate savings account for a special expenditure, such as a vacation, a new car, or a home improvement.
Not a Question of Losing Cash, But Other Risks
After the above near-term purposes, holding excessive amounts of cash may present some unknown money issues. It’s not that the cash is going anywhere if held in the bank, but it could be losing purchasing power and opportunities to grow your wealth over time.
Inflation Erodes Your Purchasing Power
This alone is reason enough to have your excess cash working for you. Even low inflation eats away at your money’s purchasing power: What $100 will buy today may only buy $75 worth of the same in 10 years from now. This is a prime factor in retirement planning and wealth planning since what we spend in the future to maintain a given lifestyle will cost us more dollars than today; that’s the effect of inflation.
Inflation is also why we invest our money; not only to grow our wealth, but to keep ahead of inflation’s constant erosion of our purchasing power. Even if you didn’t need to grow your wealth, you’d still need its purchasing power to keep up.
Your Money Is Missing Out on Long-Term Growth Opportunities
Even a few percentage points makes a big difference over the long run. Let’s say you leave $50,000 in your savings account or brokerage account, earning just 2% interest each year for 10 years (growing to $61,000 not accounting for taxes), instead of investing it in a well-diversified, balanced allocation of equity and fixed-income investments that could earn 7% over the same 10 years. If that portfolio estimation became a reality after 10 years, that $50,000 could then be nearly $100,000 or almost double what you started with.
That’s the power of compounding returns and how wealth is built. In addition, if historical inflation is about 3%, then your 2% savings account yield may not be enough to stay ahead.
A Cash Drag on Retirement
As a result, having too much cash on the sidelines means your other investments that are invested may have to perform better to get you to your objective, such as retirement, just like dragging an anchor through the water requires your boat engine to work harder. This may mean taking additional (and perhaps undesired) risk with your other investments, or you may have to work longer to achieve the same retirement savings goal, or adjust your retirement lifestyle a little lower to compensate for the reduced savings you’ll have.
What About the Stock Market and a Potential Decline?
Many people park too much of their investment accounts in cash, fearful of a potential market decline and the effect on their portfolio value. In most situations, this could be a critical mistake:
- The direction of the market in the short term is unknowable, even by those who purport to know. Forecasting by Wall Street is historically inaccurate (before and afterwards).
- Pulling money out of your long-term investments results in another question: When to put it back in? (See Point 1 above.)
- Volatility is part of the investing process. Cash may feel safe (it doesn’t fluctuate), but it doesn’t grow much either.
- Historically and in the long term, financial market growth tends to reflect economic growth and economic growth includes increases in prices, which means inflation. So if your money is invested (appropriately) in the growth of the economy, it should also grow over time, if given time and the chance to do so.
In summary, cash can be safe, secure, and a good foundation for a solid financial plan and future, but having too much may be hazardous to the growth of your wealth.
Unsure if Your Money Is Allocated Prudently for Your Family’s Future? Talk With Us.
Financial planning and wealth management are core services at Bernath + Rosenberg. We’re here to help you!
Our experienced team of Certified Public Accountants and CERTIFIED FINANCIAL PLANNER® professionals stays current with the latest in tax laws and financial strategies to help you pursue a rewarding and comfortable retirement, save on tax liability, and plan for your family’s future, according to your unique and special objectives.
To get started and make the most of your hard work, schedule a meeting by calling (212) 221-1140 or email tstricker@brwealth.com.
About Ted
Ted Stricker is a partner and financial advisor at Bernath + Rosenberg, a full-service accounting, tax, and wealth management firm with offices in Monsey, NY, Lakewood, NJ, Cedarhurst, NY, and Miami Beach, FL. The firm demonstrates a personalized approach to custom-tailored solutions and an unwavering commitment to client service. With over 26 years of experience in the financial services industry, Ted manages the firm’s wealth management team, and specializes in designing financial plans for business owners and affluent families. Since joining the team in 2015, he provides practical and sound advice, combining innovative approaches and solutions that reflect clients’ personality, lifestyle, and goals.
For the ninth year in a row, Bernath + Rosenberg has been named as one of the leading CPA firms in financial planning by Accounting Today, a publication that receives hundreds of submissions each year and features the Top 150 Firms in the nation. Ted is a CERTIFIED FINANCIAL PLANNER® practitioner and is a member of the Financial Planning Association. To learn more about Ted, connect with him on LinkedIn.
Professionals associated with Bernath & Rosenberg P.C. may be either (1) registered representatives with, and securities and advisory services offered through LPL Financial, Member FINRA/SIPC, a registered investment advisor; or (2) solely tax professionals of Bernath & Rosenberg P.C., and not affiliated with LPL Financial. Tax/accounting/CPA-related services offered through Bernath & Rosenberg P.C. is a separate legal entity and not affiliated with LPL Financial. LPL Financial does not offer tax advice or tax/accounting/CPA-related services.
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