Ever since you were a child, you were told to save your money. But as an adult, you are told that saving money, as opposed to investing it, isn’t always the best strategy. What’s the real story?
Mo’ Money? Less Invested!
You should, of course, maintain a liquid safety net and manage your debts wisely. But sitting on a pile of cash may not be the best strategy. Keeping your cash in stable vehicles like savings and checking accounts and certificates of deposit (CDs) provides security and ready liquidity, but virtually no interest income today. Inflation may be low now, but it is not zero — and if your interest earnings are not keeping up with inflation, you are, in effect, losing money,
How much cash is enough?
If retaining too much cash is bad, how much cash is enough? The short answer is that you need to maintain a readily accessible, pool of money to deal with potential disasters such as job loss, illness, or other unexpected large cash outlays. A good rule of thumb is that you should keep enough cash on hand to handle six months to one year of personal expenses in case of loss of income, along with a separate pool of money on anything that will require larger purchases (such as a targeted future down payment on a house).
Since setting a cash balance target for your family is dependent in part on your existing debts and spending habits (including such budget-denting items as family vacations), you need to analyze these factors before determining your cash balance target. Once you’ve done that, and have earmarked sufficient cash for this emergency fund, what’s left over should be dedicated to investing.
When you begin adult life, you may be shouldering a large debt load due to student loans or the purchasing of big-ticket items for your family. Not surprisingly, this leaves less cash to invest, which makes it essential for you to use every trick in the book to start building your retirement nest egg. Even small investments can have potential to grow large over time, thanks to the magic of compound interest and the availability of many tax-advantaged savings plans like a 401(k) or IRA.
Once you are somewhat older, are making more money, and have more cash to set aside for the future, the question becomes one of asset allocation. In other words, if you are holding too large a percentage of your investment portfolio in cash or cash equivalents (like money market funds), you have limited your opportunity for potentially higher returns from traditional investments like stocks, bonds or real estate.
Many experts suggest an asset allocation model weighted heavily toward stocks when we are younger and have many years to wait before retirement. This permits us to make up possible losses over time, while potentially benefitting from the historically high rate of return stocks provide over that same time horizon. However, as we get older and approach retirement, the available time to recoup possible losses is reduced. So these same experts recommend a rebalancing of our portfolio more heavily towards cash and cash equivalents as you age.
To help decide what’s right for you, it’s wise to speak with a respected investment advisor representative. You might also wish to utilize an online Asset Allocation Calculator provided by a reliable source. The bottom line to beefing up your bottom line: the younger you are, the less cash you should carry in your investment portfolio; the older you are, the more cash you should carry.
Winnie Sun is a registered representative with, and securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Sun Group Wealth Partners, a registered investment advisor and a separate entity from LPL Financial.