Comforts of Cash

Dennis Friedman

I HAVE TO ADMIT IT, I’m one of those guys who likes to hide money. I have cash hidden in a couple of places in my house and even in the garage. And I’m not talking about a few dollars. I probably have more than $3,000 in denominations large and small tucked in envelopes. I also have a jar of coins.

You might ask, “Why in the world would someone have so much cash lying around the house?” I keep it on hand in case of an emergency. For instance, earlier this year in Texas, the electrical power grid was severely damaged by winter storms. Because the power was down, some Texans couldn’t get access to money through an ATM or even use their credit cards to purchase food.

I live in California, where we occasionally have earthquakes. The possibility of a natural disaster happening here is real. I think everybody should have some cash readily available for the unexpected.

I know some people dislike carrying cash, but I’m not one of them. I like to carry a wad of bills because you never know when you might need the real stuff. My wife and I went to a farmers’ market the other day where many vendors don’t accept credit cards. Luckily for us, I had cash to pay for our purchases.

When I have my car worked on, my mechanic gives me a discount if I pay in cash or with a check. He’s always willing to pass along the savings on credit card transaction fees to his customers. Sometimes, I pay in cash when I’m visiting one of our favorite independent restaurants, knowing in a small way it might help their bottom line.

Although I believe cash is useful in pursuing short-term goals, I would never keep a significant amount in my investment portfolio. Compared to bonds and stocks, you just don’t earn a lot on cash investments like a money market fund or a savings account. Result: I use cash primarily for our emergency fund that covers six months of living expenses.

What you can expect to earn on the three major asset classes—stocks, bonds and cash—depends on the risk level of those investments. The higher the risk, the greater the reward an investor expects as compensation for taking on that risk. Since there’s practically zero risk in cash investments, you don’t earn much.

When you look at the average return of the three asset classes, you find their ranking is determined by their level of risk. A Vanguard Group article showed how the three asset classes differ in risk and reward.

Cash investments

  • Main risk: Losing ground to inflation
  • Long-run average return: 3.5% a year before inflation, 0.6% a year after inflation
  • Percentage of years with negative returns: 0%

Bonds and bond funds

  • Main risk: Rising interest rates
  • Long-run average return: 5.5% a year before inflation, 2.5% a year after inflation
  • Percentage of years with negative returns: 16%

Stocks and stock funds

  • Main risk: Stocks can suffer severe losses
  • Long-run average return: 10.2% a year before inflation, 7.1% a year after inflation
  • Percentage of years with negative returns: 28%

As you can see, holding a large amount of cash will likely reduce your rate of return over time. There’s no free lunch in investing. If you want to earn a decent return on your money, you need to take some risk. Asset allocation—your basic mix of stocks, bonds and cash—plays a crucial role in an investment portfolio’s performance.

Here’s a general rule of thumb: If you need money in less than a year, keep it safe in cash investments. If you don’t need money for more than 10 years, invest in stocks. If your need for money falls somewhere between these two points, use a mix of bonds and stocks that squares with your financial goals and tolerance for risk.

Dennis Friedman retired from Boeing Satellite Systems after a 30-year career in manufacturing. Born in Ohio, Dennis is a California transplant with a bachelor’s degree in history and an MBA. A self-described “humble investor,” he likes reading historical novels and about personal finance. Check out his earlier articles and follow him on Twitter @DMFrie.

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