Why is cash considered king (or Queen)?

When people talk about cash, are they talking about cash stashed under a mattress?

I have noticed that the layperson is not often clear about what people mean when they use the term cash. So let me start there. When we talk about cash, people are often talking about putting your cash into a financial instrument that has the combination of liquidity and zero risk (well, remember there is no such thing as zero risk but you know what I mean).

• Liquidity means you can withdraw the money anytime easily and quickly
• Zero risk essentially means the money and return is protected from any risks and is guaranteed.

Below detail is a US-centric view but in general, conceptually this is similar in other parts of the world as well.

So why is cash considered king?

Now that we have defined what we mean by cash, lets talk about why keeping money in cash is considered good.

1. Emergencies: The number one reason for keeping cash is for emergencies. I talked about this in my article on the emergency fund. In times of emergencies, you don’t want to be looking for money to pay your bills by liquidating your assets like stocks or trying to sell your car or jewels. You need to have cash in hand. I always recommend keeping around 3-6 months of expenses worth of cash in hand. Personally, I am more conservative and like to keep around 9 months of expenses in cash.
2. Short term purchases – you should also be keeping cash in hand for any short term needs you may have. This could be a vacation, or a planned purchase like a home down payment.
3. Taking advantage of investment opportunities – having cash in hand gives you a lot of power to take advantage of investment opportunities at different points of time. This should be done only after you have set aside money for items 1 and 2 above.
4. Buffer against bear markets – depending on who you talk to, this means something different. Some people move a lot (or in extreme cases) of their portfolio to cash to buffer against market downturns. I don’t advocate that because that’s essentially trying to time the market. I will talk more about that later. But some others keep more cash using what they call a ‘barbell allocation’ where they balance an extremely aggressive portfolio with extremely conservative portfolio (essentially around a 50-50 mix) so they can weather the extreme downturns.

So why can’t I just keep all my money in cash?

The answer is obvious, but I will say it anyway – keeping money in cash means you lose money because of two reasons –

• Inflation – Inflation means your money loses value over time.
• Opportunity cost- Opportunity cost means you missed out on higher return opportunities by keeping your money in cash.

The inflation reason does not need much explanation. Its fairly intuitive. If inflation is 10% annually, $100 kept in cash last year is worth only $90 this year – so it lost value. But if you invested the money in something that could beat inflation – so in this example, if you invested in something that provided you more than 10% returns, then you did Ok.

Which brings us to the other reason – since keeping money in cash, in the instruments I laid out earlier is zero risk, it also means it comes with limited returns. On average, the rate of return will vary based on prevailing interest rates. But in the long run, investing in stocks will outperform putting money in cash in savings accounts for eg – by a long shot. That’s the risk of opportunity cost. Unless you are a retiree who is 100% focused on wealth preservation and don’t care about growth of your portfolio and have accumulated a large nest egg that you are confident will last their life-time – then sticking it in cash might be OK – even though the retiree will lose money to inflation and opportunity cost.

If other asset classes are not performing, why can’t I stick all my money in cash?

At the time of writing this article, we are getting close to 4% returns by putting your cash in the types of zero-risk instruments I laid out earlier in the article. That’s actually quite high compared to what we have been used during the last decade or so where the returns have been below 1%.

Also, people are observing the returns on other traditional assets like stocks are not exactly high and more importantly, volatile. So, people are really starting to move toward zero risk assets to at least get a guaranteed 4% return. This is also why people are starting to gravitate back to assets like gold and Bitcoin.

For the average investor, I recommend sticking to your long-term strategy and simply keeping only as much money in cash as you need for the items I mentioned earlier. Why do I say that? Because – If you pull money out in bear markets, then you are going to struggle to time the market to get back into the market. What does that mean? You either pulled money out of the market or stopped investing in the market because it’s a bear market. Now, you need to decide when to get back into the market. There is no magical gong that goes out announcing the end of the bear market to let you start re-investing. You have to essentially guess. Sophisticated day-traders get this wrong. So, what makes you think you or I will get it right?

Ok, if not 100% in cash, how much should I keep in cash?

There is no golden number or % to be honest. Different financial advisors will give you different numbers. I don’t like looking at this as a %, but simply as absolute $ for the purposes I laid out earlier. Why is that? Because this totally depends on the actual needs and expenses of each individual and is relative to the amount of their wealth/net worth. So, if I need $50K in my emergency fund and my total net worth is $500K, that’s 10% in cash. On the other hand, if I need $50K in my emergency fund and my total net worth is $5M, then the individual only needs to keep 1% in cash. You might choose to keep more to help you sleep at night. That’s totally fine as long as it fits your strategy and long-term goals. I personally like to keep cash for our emergency fund and then after I take care of all long term needs and goals, if I have any money left, I put it in a short-term savings account that I use to take advantage of real-estate opportunities. That’s part of my goals and strategies – so it makes sense for me. It might not make sense for someone else who might be better off just channeling all that money into the stock market each month.

Concluding comments

Having cash in hand is a good thing. But too much of anything is not good. You need to have a balance. As I mention, stick to your long-term strategy and you will be just fine. Cash has its uses and should be leveraged appropriately for that.

Thank you for reading and I wish you success in your personal finance journey!