Deciding on whether to hold cash or invest in stocks is a tricky decision given the coronavirus pandemic and the volatility in 2020. This article will try to answer this key question to make proper risk-adjusted investment returns.
Did you know that according to Gallup, 46% of Americans don’t own any stocks? Part of the reason is that two-thirds of US workers don’t participate or have access to a 401(k) plan.
Whether you’ve never invested before or are a veteran investor nervous about the state of the financial markets, there will be times in your life when you’re wondering, should I hold cash or invest it?
What are some things to consider when determining how much cash you should hold?
- Your investment strategy goals
- Current and future liquidity needs
- How many different income streams you have
- Inflation and changes in purchasing power over time
- Your risk tolerance during volatile markets
- The diversity of your assets
Hold Cash Or Invest In Stocks
What is liquidity? Liquidity measures the degree to which an asset can be purchased or sold without affecting its price. Another way to put it is this – the easier an asset can be converted to cash, the more liquid it is.
Examples of highly liquid assets are bank deposits held in checking, savings and money market accounts. Other highly liquid assets are blue chip stocks, T-bills and corporate commercial paper.
On the other end of the spectrum, examples of illiquid assets include micro cap stocks, private equity, real estate, bank debt, and over the counter securities such as credit default swaps.
What Are The Benefits Of Holding Cash?
Cash has many benefits. Some key benefits of holding cash include
- Avoiding high interest payments and late fees common with credit
- Easily transferable and quickly accessible
- FDIC protection on balances up to $250,000 at most banks
- Helps preserve capital in down markets
- Useful for emergency expenses
As a general rule, your savings should be sufficient to cover all of your personal expenses, including your mortgage, loan payments, insurance costs, utility bills, food, and clothing expenses for at least six months. That way, if you lose your job, you’ll be able to have sufficient time to adjust your life without the extreme pressure that comes from living paycheck to paycheck.
Any specific purpose in your life that will require a large amount of cash in five years or less should be savings-driven, not investment-driven. The stock market in the short-run can be extremely volatile, losing more 35 percent on average in a bear market.
Purchasing a home within a year or two is a great example where saving your cash makes sense. I personally plan to buy a nice beach house in Hawaii for $3-4.5M, therefore, I need as much cash as possible.
Is It Better To Invest Or Just Keep Cash?
There’s no right or wrong answer to how much cash you should hold as an asset. Curious what other people do? CNBC reported that investors held 23 percent of their assets in cash and cash equivalents on average. That’s pretty high considering many registered investment advisors recommend holding only about 10 percent. “Cash drag” can weigh down a portfolio’s returns.
A study by Hearts & Wallets found that gender is also a factor in how much cash a person tends to hold. They reported that women allocated 37 percent of their assets to cash compared to 25 percent for men.
In general, Financial Samurai recommends having no more than six months worth of living expenses in cash. And hopefully, the cash is optimized in a high yielding online savings account like the one from CIT Bank, my favorite online savings bank with some of the highest interest rates.
Your age can also impact how much cash you should hold vs invest. The closer you get to retirement, the more important liquidity typically becomes. When your primary source of income stops, access to cash and liquid assets is vital. Increased liquidity also helps you enjoy your free time in retirement.
How and when to deploy cash will depend on your own personal style and investment goals. For example, you might choose to invest a third of your cash if the S&P 500 falls by 5 percent, another third if it falls 10 percent, and the remainder if prices fall 15 percent or more.
Other methods you could use to decide when to deploy cash could include triggers based on economic figures, actions by the Federal Reserve, the government, or exogenous events like COVID-19.
Make Your Cash Work For You
After deciding how much cash you want to hold, set up automatic transfers to deploy any additional incoming capital above your target. This way you won’t end up with more cash than you want as each month goes by.
Don’t risk storing your cash in barrels or hidden behind wall panels like on Netflix’s show Ozark (a highly entertaining show if you haven’t watched it!) Instead, I recommend keeping your cash balance in a high yielding money market savings account.
CIT Bank offers the best rates I’ve found. Use them to keep your cash optimized.
It’s always a good idea to have at least six months of expenses in cash. Much more than that depends on your level of risk tolerance and cash flow.
I’m personally investing aggressively in real estate given mortgage rates have collapsed and there’s a desire to invest in more stable assets.
Diversify Your Investments Into Real Estate
Stocks are very volatile compared to real estate. Therefore, if you want to dampen volatility and build wealth at the same time, invest in real estate. Real estate is my favorite asset class to build wealth.
The combination of rising rents and rising capital values is a very powerful wealth-builder. In 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates.
I did so by investing $810,000 with real estate crowdfunding platforms. With interest rates down, the value of cash flow is up. Further, the pandemic has made working from home more common.
Take a look at my two favorite real estate crowdfunding platforms. Both are free to sign up and explore.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified eREIT is the easiest way to gain real estate exposure.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. If you have a lot more capital, you can build you own diversified real estate portfolio.
Manage Your Wealth Wisely
It’s my belief that Personal Capital is hands down the best online wealth management platform with free financial tools you can use to help manage your finances and achieve a more secure retirement. I’ve tried everything from Excel, to Mint, a plethora of other financial apps, and nothing comes close to Personal Capital’s tools.
With Personal Capital, you can do the following things for free:
- Automatically track your net worth
- Analyze your investment portfolios for excessive fees
- Analyze your investment portfolios for proper asset allocation
- Track and manage your income and expenses
- Run various retirement planning calculations to ensure a better financial future
Staying on top of all of your financial accounts in one place offers simplicity and less stress. You can track your net worth, cash flow, save money on fees, balance risk, find investment efficiency and so much more. Leverage technology and sign up for your free account today. It takes less than a minute to sign up. Everybody should give it a try.
Hold Cash Or Invest It In Stocks Or Real Estate Is A Financial Samurai original post.