Cash is Trash is a saying you often hear investors make. This phrase was most recently spouted by Ray Dalio. He said it in 2020 and he is still saying it. On the other hand, investors like Warren Buffet are known for holding a good bit of cash. In the latest Berkshire-Hathaway investor newsletter, Buffet said he likes to hold 30 billion in cash.
Some investors believe you should have 10-20% of your portfolio in cash. Today I’ll look at some of the pros and cons of holding large cash positions. I’ll also look at the YTD performance of it compared to the total stock market.
Disclaimer-At the moment, 20% of my net worth is in cash. I normally don’t have so much in cash; however, I plan to buy a house at some point in the next three years. After that’s completed, I can’t see myself holding such a high percentage in cash, especially as my net worth increases.
- What’s Cash
- Pros of Holding Cash
- Cons of Cash
- YTD performance of cash vs. stock market
- My short-term plans
What is Cash?
Cash is a short-term, liquid, currency-based asset class. Cash equivalents can be money market funds or the shortest-term treasury bills (4 weeks). In summary, to be considered “cash”, it doesn’t have to be Benjamin Franklins in your hand. Checking and savings accounts are both considered “cash.” Cash has the least risk of any asset class. Losing your purchasing power is the primary risk of holding cash.
Pros of Holding Cash
- In the event of a market correction, you have money to buy equities with it.
- One car/house repair, or, one medical bill can wipe out thousands from your emergency fund.
- You can sleep well with a large cash cushion, knowing you are equipped for hard times.
- With interest rates rising, it makes less sense to use credit cards for larger purchases.
Dry powder to buy stocks with
In 2019, I made the mistake of always buying something every week. I would run my cash reserves dry. Sometimes the market would correct and I wouldn’t have anything to buy with. Lesson Learned! This is why I try to maintain a 5% cash position no matter what. When deals come up, I can participate.
Big expenses can suddenly wipe out an emergency fund. In 2021, I had the unfortunate circumstance of an Emergency Room visit. I had health insurance, but my deductible was $5000. I had barely been to the doctor that year, so none of my deductible had been used. To make a long-story short, that one instance wiped out about $4300 of my cash savings. Lucky me, I had a good bit of cash built up. If someone only had $5000 in their emergency fund, they wouldn’t have been in a good place. I lean more on the conservative side of things here. I think $5000 is not enough for an emergency fund. One can argue all day about whether to have six months or a year’s worth of expenses built up. I think a year’s worth of expenses is the bare minimum to shoot for. Of course, this depends on your career income levels. The more you make and the less your expenses are, the less you need in your Emergency fund.
One of the best reasons to have a large cash cushion is so you don’t make irrational moves in the stock market. Suppose your stocks are down 25%? No big deal if you have a large cash position. It will roll off your back like water off a duck’s back. A large cash cushion gives you a psychological benefit to stay the course.
Cash vs. credit card
One common argument is “just put large purchases on a credit card.” I don’t like this approach during rising interest rates. During times of high interest rates, you are better off paying the debt off. Otherwise, you could be losing 5-10% annually or even worse if you don’t have a good credit score. I think putting it on a credit card makes more sense when the interest rates are LOW. Not to mention at higher interest rates, you are rewarded more with higher yields on your cash.
Another argument is inflation helps erode debt, so take on debt. However, that is only the case if your wages go up! I can tell you, my wages are NOT going up enough to offset inflation. It only works if you are/were lucky enough to lock in the debt at lower interest rates. Context is everything.
Cons of Holding Cash
- Opportunity cost; almost risk-less investments like Treasuries and I-bonds are paying more
- Opportunity cost of investing in equities that COULD increase more
- Account maximums
- Interest on cash is taxable
- Loss of purchasing power due to inflation
6 month and 1 year treasuries are paying almost 3%. If your savings account is only paying 1.5%, then you are missing out on an additional 1.5%. There’s also the potential that equities could increase more and you miss out on even greater gains. For example, the stock market just came off one of it’s best performances for the month of July.
Many savings accounts have a maximum on how much you can put into them and still get higher rewards. So if you are higher net worth and want to put above 60K in cash, you might need more options besides a savings account. You’ll need to go with Treasuries or Money Market accounts.
Interest on savings or checking accounts is taxable. It’s taxed as ordinary income as well. Meanwhile, Treasury bonds are not taxable at the state level. (Disclaimer-I am NOT a certified tax specialist, only repeating common knowledge, please consult your accountant)
Loss of Purchasing Power
The biggest con of holding cash is that long-term you lose purchasing power. Lately, this is primarily due to inflation. When inflation is 9%, your cash is not making enough to keep up with the loss of your dollar’s purchasing power.
Performance of Cash vs. Total Stock Market YTD
To date, the total stock market (ITOT is my reference) is -15%. If you tack on 9% inflation, you’re down -24% in real terms.
Suppose you stuck your cash in my credit union that pays 1.5% for checking accounts? You’re down -7.5% in real terms. You saved yourself 16.5% in losses by holding cash.
This is all short-term and we are looking backwards in time. We have no way of knowing what the market will do in the future. Long-term, we know that cash is a losing proposition. Especially with the increase in money supply and debt levels of our government. Cash isn’t a place you want to be long-term.
My short-term plans
I’m actually looking at buying 6 month and 1 year Treasuries at 3% through Fidelity. This is twice as much as my checking pays. I already have a good bit in Ibonds, but not the maximum for the year. However, I currently can’t add any more because I’m still waiting for the Treasury Department to approve my new account. So, treasuries are the only solution I have besides CD’s; CD’s aren’t paying enough to make it worth the hassle of switching over.