The Cost of Having Too Much Cash
Head of Partnerships
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Regardless of whether you’re just starting out in your career, or you’re on the fast track to an early retirement, effective cash management needs to be an essential part of your financial plan. Particularly in Asia, where saving is such an ingrained part of its culture, many people have too much cash in their overall personal portfolios. That’s right: Just as there’s such a thing as not having enough cash, there’s definitely such a thing as having too much cash.
Here, we’ll unpack the latter: How much is “too much” cash? And why is “too much cash” a bad thing?
Why too much cash is actually a bad thing
Cash may appear to be liquid and safe, but the reality is that if you have too much of it and the cash you do have isn’t in the right vehicles, your cash isn’t safe.
That’s right— cash, when improperly managed, isn’t safe.
What we mean by that is that you’re actually losing money when your excess cash isn’t in the right vehicles, because the purchasing power of cash inevitably decreases with inflation. And that’s why having “too much cash” is a bad thing.
Cash is an asset that, just like any other asset, must be managed wisely and intentionally. Because cash inherently doesn’t grow in value, you can maintain or grow its value only when you put it in instruments that enable it to do so.
Nominal returns (before deducting for inflation): Current Account: 0.05%, StashAway Simple™: 1.4%, and Invested: 6%. And, Singapore's inflation rate: 1.4%. As of 1 December 2021, Simple’s projected rate is 1.0%. This chart still reflects the importance of not leaving your money in cash.
Think of it this way: Compound interest works in the other direction, too. The longer you have excessive cash just sitting there, the more money you’re losing to inflation.
How much cash you should have
Because cash loses its value over time, it’s important to understand exactly how much cash you should have and where you should keep it.
The purpose of having liquid assets, usually in the form of cash, is to have access to it for short-term expected and unexpected events. Ask yourself why you have the amount of cash you have. Does every unit of cash you have truly serve a specific purpose?
In your current account, or checking account, you should have just enough to cover your monthly expenses in a current account. This minimises the amount of cash that’s exposed to the teeth of inflation.
For your emergency fund and short-term goals, keep your money in a low-risk, liquid, interest-earning vehicle. This may be a savings account, money market fund, fixed deposit account, or other cash management vehicle. When you’re assessing where to put these, make sure that your entire balance is at least keeping up with inflation (Singapore’s inflation rate over the last 15 years was 1.8%, but most savings accounts in Singapore with balances of $150,000 SGD could earn only about 1.4% or less on that full balance before trying to meet the banks’ salary, credit card, insurance, and other requirements.)
Speaking of which, we recently launched a cash management portfolio, StashAway Simple™. It has a projected 1.2% return on any amount (seriously, any balance has that projected return), with none of the hassle of investment requirements, credit cards, tiered earning structures, and whatever else the banks have come up with to make it painful to manage your cash.
Note: As of 1 December 2021, StashAway Simple™ has a projected rate of 1.0%.
Being risk-averse isn’t an excuse for having too much cash
If you’re risk-averse, you’re probably afraid of losing money. And, as we know, if you have too much cash, the value of your money is most definitely declining. Sure, your cash doesn’t have a huge downside (and this is what makes it inherently makes it low-risk), but having too much cash does mean you’d be unnecessarily writing a death sentence for a portion of your cash.
It can be deceiving to think that you aren't losing money, because unlike investment accounts that show your positive or negative returns, current accounts don’t show that the cash's purchasing power is actually declining. You need to remember that just because you don’t see the absolute value of your cash declining in your account, the real value of your money is still decreasing, and that in practice you're actually losing money. It’s like being in an investment that has an invisible ever-worsening negative return. Though cash itself isn’t an investment, it’s still an asset that you must manage intelligently as part of your financial plan.
If you consider yourself risk-averse, there are low-risk, medium-to-long-term investment options that can earn you more than what cash management solutions might.
In fact, our lowest-risk investment portfolio has earned about 9.85% since 2017. How? “Low risk” means that you’re not exposing yourself to a large downside, not that you can't earn returns. Our investment framework, ERAA®, strategically and uniquely maximises returns within a given risk constraint. Your money should be accessible and low-risk, and that’s why we don’t have any lock-up periods.
What about investment portfolios that have cash as part of the allocations?
Dividends that don’t get reinvested can cause cash allocations in portfolios to compound. At StashAway, we reinvest your dividends to make sure we’re making the most of your investments.
We also use fractional shares down to 0.0001 of a share to maximise the power of your cash. Most fund managers don’t do that. To be as efficient as possible with your investments, we target a 1% cash allocation for your portfolios.
How to manage your cash and investments
Your cash management strategy is absolutely part of your long-term financial plan. Just as a successful long-term financial plan requires discipline not to overspend on your monthly budget, and not to tap into your emergency fund for non-emergencies (no matter how badly you think you need that vacation, we promise you it's not an emergency), it also requires discipline not to liquidate your long-term investments unnecessarily.
Irrationally, people often “get in and out of the markets” when they feel uneasy about the markets or economy, or if they’re trying to capture earnings when they think the markets are high. We already know that the likelihood of you re-entering at the ideal time is slim to none, usually ultimately resulting in lower potential returns.
But, there’s another problem with taking your money out of medium-to-long-term investments: It increases your cash allocation for an indefinite amount of time. That means that suddenly your money went from a long-term growth strategy to most definitely not earning anything. Plus, when are you going to go back in? Right away? In a year from now? Who knows! You could be waiting months, missing out on the markets’ opportunities, and losing to inflation.