Cash—such as money stowed away in bank accounts and money market funds—isn’t the most glamorous investment. Its value doesn’t fluctuate on a daily basis like stocks do, and (especially in the low interest rate environment of the last few years) it doesn’t grow much over time. Yet having the right amount of cash is an important factor in achieving your financial goals.
A common mistake is to have too much cash, whether out of fear of the ups and downs of financial markets or just because you never got around to putting it into other investments. Holding a lot of cash can make your portfolio seem “safer” by limiting the amount that its value bounces up and down on a daily basis. But over the longer term cash investments are likely to gain far less than other assets, such as stocks and bonds. The return on cash may not even keep up with the inflation rate, let alone grow enough to meet your financial goals.
Too little cash can also be a problem, and there are good reasons not to allocate all of your money to more volatile investments. Financial planners generally recommend keeping about six months’ worth of your typical expenses in cash as a buffer in the case of an emergency, such as losing your job or unexpected medical expenses. And if you have short-term financial goals, such as large expenses that you’re going to incur in the next year, keeping this money in cash helps ensure that your ability to make the payments isn’t dictated by the whims of financial markets.
It’s therefore important to have enough cash to fund your short-term needs but not so much cash that it stunts your portfolio’s potential growth. Getting this balancing act right can give you both peace of mind and the best chance of reaching your financial goals.