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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.

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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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Lynne
Lynne
2 months ago

Since retiring to Mexico, I don’t have much choice. It’s a cash society. You can use credit cards in big stores and fancy restaurants, but that’s about it. And not just cash, but small bills.

gregorit
gregorit
2 months ago

I’ll have to differ: I keep as little cash as possible. I haven’t been to an ATM or cashed a check in decades. (The ONLY usage I have is when I go to the casinos or track and for that I have a separate ‘pile’.) As far as liquidity goes, I have cash-equivalents in my brokerage account. I have a HELOC I can draw upon. (If one of my kids gets kidnapped?). If somebody needs a cash payment then PayPal or Venmo will suffice if a credit card can’t be used..

At a portfolio level, my cash % varies – I’m preparing for retirement and am trying increase income – that means I’m selling options and often that implies cash-secured puts so I end up with extra cash. Sadly, my biggest usage of cash is tax payments.

R Quinn
R Quinn
2 months ago

I agree, but also realize the largest source of lost tax revenue to the IRS is business and individuals who are paid cash. That mechanic is probably doing himself more of a favor than given to you.

Ginger Williams
Ginger Williams
2 months ago
Reply to  R Quinn

Not reporting cash income is a short-sighted decision. It saves taxes, but it has a long-term negative effect on social security.

parkslope
parkslope
2 months ago

Not reporting cash income obviously may or may not reduce lifetime income (including SS).

R Quinn
R Quinn
2 months ago

True. I know people who report up to SS taxable wage and then no more.

Guest
Guest
2 months ago

Thanks Mr.Friedman. I also like having plenty of cash handy but have not yet resorted to hiding it in multiple spots in our house. When my 85 year old mom died a few years ago we were astonished to find how many weird places she hid wads of cash. In our investment accounts, while I am far from a market timer, stocks and bonds at these levels make me very comfortable having far more cash than usual. I’m fortunate to not need to take on the extra risks associated with equities and fixed income. That means I lose after inflation. So what. I sleep very well. The whole “There Is No Alternative” idea for investing in stocks, as if they won’t go down (sometimes a lot) I find is a load of garbage.

Roboticus Aquarius
Roboticus Aquarius
2 months ago
Reply to  Guest

TINA doesn’t suggest stocks will never decline. It’s merely pointing out that if you want any kind of return on liquid investments, the stock market is the only game in town (unless, of course, you want higher risk investments).

I think it’s wise to hold some cash, especially when you have less need for risk. There are times that cash returns have beaten bonds and stocks.

Guest
Guest
2 months ago

“It’s merely pointing out that if you want any kind of return on liquid investments, the stock market is the only game in town.”

You contradict yourself RA. That very sentence makes it sound like you will get a positive return anytime you own stocks. And that is a dangerous assumption. I stand by my comment but thank you.

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