Is there such a thing as too much cash?

Posted by admin on July 9, 2008 in Investment Strategy

With the stock market in bear territory and the real estate market in decline, the obvious reaction for most people is to keep a lot of cash around. Mutual fund associations report that sales are up but most sales are in money market funds. Thus, while we are saving, it is, for the short-term, parked on the side-lines in non-appreciating investing products. I am not unlike most people; I have over 25% of my portfolio in cash/money market funds.

Having cash on hand is a good thing but is having too much cash around a bad thing?

For short period of times, probably not. Cash is a real psychological comfort zone in uncertain times such as this. However, from an opportunity cost perspective, you could be losing out on some real opportunities in the medium to long term if you have too much cash on hand. The greatest threat to anyone’s net worth is inflation; a dollar today is not worth a dollar a year from now. If you sit on too much cash, even in a high-interest savings account, your interest could be equal to or less than the rate of inflation in which case your net worth is going side-ways or backwards. This is especially true in an environment like today’s where a money market account is yielding approximately 2-3% per annum but inflation is running way ahead of that rate. If nothing else, inflation eats into your hordes of cash and makes it worth less over time.

Thus, at some point in time, it makes more sense to use some cash on hand to invest in long-term appreciation plays like dividend-yield stocks and quality real estate. Although Jeremy Siegel admits stocks in the short term are poor inflation hedges, they are, over long periods of time, better hedges against inflation than cash or bonds.

What is an ideal amount of cash to have on hand? It depends. Most asset allocation models suggest anywhere from 15%-25% of your portfolio during 2008 (it depends on how gloomy your out-look, how close you are to retirement, your risk tolerance etc). Anything over 30% for someone who is not close to retirement seems excessive and overly conservative (even given the performance of the market in July).

You can’t get hurt if you don’t play the game but they don’t give 1st place medals if you never enter the field either.

1 Comment on Is there such a thing as too much cash?

By Sampson on July 9, 2008 at 11:34 am

Great post and I wholeheartedly agree that cash on the sidelines (even in money market accounts) is not the best way to grow or as you point out even maintain wealth.

As with most people on your site and other popular blogs, I am a value-oriented investor with very longterm horizons (25 yrs in my case). With the markets in their current state, I’m actually finding it very difficult to stick with my set allocation of cash. I’m chomping at the bit looking at everything heading downwards and its a bit of a fight to maintain that minimum cash allocation (a measly 5% in my case). I just wonder if others are feeling the same, or are most feeling what is generally reported, cash hoarding!?!