Cash Value Investing: Strategies For Long-Term Wealth Preservation

Holding cash can be a great short-term investment option, but it's not always the best choice for long-term financial goals. While cash investments are generally considered safe and liquid, they often provide lower returns compared to other investment options. This is especially true when considering the impact of inflation, which can cause the value of cash holdings to decrease over time. For example, if you plan to buy a $1,000 computer next year and put that amount in a savings account with a 1% interest rate, you'll have about $1,010 by the end of the year. However, if inflation rises by 2%, the same computer might cost $1,020, resulting in a loss of purchasing power.

On the other hand, cash investments can be ideal for emergency funds or short-term savings. They provide easy access to funds, ensuring you can quickly cover unexpected expenses without worrying about market fluctuations. Additionally, cash investments can be a strategic choice during volatile market conditions or when waiting for the right investment opportunity.

To make the most of cash value investing, it's essential to consider factors such as your financial goals, risk tolerance, time horizon, and current market conditions. Striking a balance between cash holdings and other investments, such as stocks or bonds, is crucial for optimizing your investment portfolio and achieving your long-term financial objectives.

Cash vs stocks: pros and cons

Holding cash can be a conservative investment strategy, but it may not always be the best option. While cash holdings can provide liquidity and stability, they may not generate meaningful returns or keep up with inflation. On the other hand, investing in stocks offers the potential for higher returns but comes with higher risks and volatility. Here are the pros and cons of cash vs. stocks:

Cash:

Pros:

• Liquidity: Cash provides immediate access to funds, making it ideal for short-term savings or emergency funds.
• Stability: Cash is a stable asset that doesn't fluctuate in value like stocks. It offers peace of mind, especially during periods of market uncertainty or economic downturns.
• Low Risk: Cash holdings are generally considered low-risk investments. They are typically insured by the Federal Deposit Insurance Corporation (FDIC) or similar institutions, guaranteeing the safety of your funds.
• Flexibility: Holding cash gives you the flexibility to take advantage of new investment opportunities or make large purchases without relying on credit.

Cons:

• Low Returns: Cash holdings may not generate significant returns over time. While they can provide a small amount of interest, it often fails to keep up with inflation, resulting in a loss of purchasing power.
• Opportunity Cost: Holding cash means missing out on the potential gains of investing in stocks or other assets. This opportunity cost, known as cash drag, can be significant over the long term.
• Inflation Risk: Inflation can erode the buying power of cash. As interest rates rise, the value of your cash holdings may decrease relative to the increasing prices of goods and services.

Stocks:

Pros:

• Higher Returns: Historically, stocks have offered higher returns than cash savings. Over the long term, they have the potential to outperform inflation and provide greater growth for your investments.
• Capital Appreciation: Stocks provide the opportunity for capital appreciation as companies grow and increase their profits. This can lead to significant gains for investors.
• Dividend Income: Many stocks pay dividends, providing a source of regular income for investors. Dividend-paying stocks can be a stable source of income, especially for retirees or those seeking consistent cash flow.

Cons:

• Volatility: The stock market is subject to ups and downs, and stock prices can fluctuate significantly. This volatility can be challenging for investors to manage and may lead to panic selling.
• Risk: Investing in stocks carries a higher level of risk compared to holding cash. There is always the possibility of losing some or all of your investment if the stock price declines or the company goes bankrupt.
• Market Timing: It is difficult to time the stock market, and pulling your investments out during downturns can result in missing out on potential gains when the market recovers.
• Fees and Charges: Investing in stocks often incurs various fees and charges, such as fund management fees, buying and selling fees, and other account charges, which can reduce your overall returns.

How much cash should be in your portfolio?

Holding cash can be a strategic part of your investment portfolio, but it's important to understand the risks and benefits. Cash and cash equivalents such as certificates of deposit (CDs) and money market funds are among the safest and most liquid investments. They are available when you need them, and there is little risk to the principal amount.

However, cash has historically not generated returns above the inflation rate, which means that you are not increasing your purchasing power over time. This is an important long-term investing goal, and cash is not a substitute for stocks or bonds, which have the potential for higher returns.

The amount of cash you should hold in your portfolio depends on your personal situation, financial goals, risk tolerance, and time horizon. A general rule of thumb is that cash and cash equivalents should comprise between 2% and 10% of your portfolio. However, this will vary depending on individual circumstances.

• Emergencies and unexpected expenses: It is generally recommended to keep at least three to six months' worth of living expenses in highly liquid cash reserves for emergencies such as job loss, accidents, or unexpected medical bills. This ensures that you don't have to sell stocks or other assets at inopportune times.
• Short-term investment opportunities: Holding a modest percentage of your portfolio in cash allows you to quickly take advantage of short-term investment opportunities, especially during market disruptions or fluctuations. This is more applicable if you are focused on wealth accumulation and can tolerate more investment risk.
• Retirement planning: If you are a retiree or nearing retirement age, having a larger cash reserve becomes more important. It provides peace of mind and ensures you have sufficient liquid reserves to weather economic downturns or periods of uncertainty. Financial advisors typically recommend that retirees keep at least one to two years' worth of expenses in cash or other low-risk assets.
• Large purchases or expenses: If you are planning a big purchase or expense within the next few years, such as buying a home, paying for education, or renovating your house, it makes sense to set aside extra cash in advance.
• Income and net worth: If you have a steady income and can rely on a consistent paycheck or annual bonus, you may require a smaller cash position. On the other hand, if your income varies, such as with independent contractors, keeping more cash reserves can protect against unexpected income shortfalls or expenses.

While cash can be a strategic part of your portfolio, it should not be the majority of your holdings. It is important to be mindful of the opportunity cost of holding too much cash, as it may slow your progress toward your financial goals. Instead, consider diversifying your portfolio with stocks, bonds, and other investments that have higher potential returns.

Cash as an emergency fund

Holding cash as an emergency fund is a good idea, especially if you know you will need access to your money within a year. For example, if you know you will be doing a renovation in December and plan to start saving in January, you can put that cash in a bank savings account, where it has no chance of losing value in the market.

Most financial professionals recommend keeping at least three to six months' worth of expenses in cash in highly liquid assets so that you can use them in an emergency, although the amount will vary depending on your situation. For example, if you have $10,000 in monthly expenses, $10,000 in an emergency fund likely won't be enough. However, if your monthly expenses are $2,000, a $10,000 emergency fund may be more than sufficient.

You can invest your emergency funds in more liquid assets so that you can earn money and convert the assets into cash quickly. Liquid assets like money market accounts, high-yield savings accounts, and certificates of deposit (CDs) are among the ways you can invest your emergency fund money so that it can grow and remain accessible.

Money market accounts are interest-bearing accounts at banks or credit unions that are a sort of mix between a checking account and a savings account. They are considered low risk, so they can be ideal for an emergency fund. Money market accounts can provide APYs of about 3% to 4%. Most money market accounts are insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Association (NCUA), which means your money will be protected up to $250,000 per account.

A high-yield savings account, often offered through online banks, can also provide returns while keeping your emergency fund safe. These accounts generally provide higher interest rates than traditional savings accounts. You can earn 3% to 4% from many high-yield savings accounts compared to an average APY of about 0.3% from traditional savings accounts, according to the FDIC. Money in a high-yield savings account, including online-only accounts, is typically FDIC-insured.

A certificate of deposit (CD) can also provide more interest than keeping your money in a checking account. Like a money market account and high-yield savings account, a CD offers FDIC protection for up to $250,000 per account. Generally, CDs with longer maturities (such as five years) have higher interest rates. However, one drawback is that you usually must pay a penalty to cash out a CD before it matures, which makes it more difficult to access your money if you need it immediately.

While cash can be ideal for short-term or emergency savings, it may not be the best option for long-term savings. This is because cash does not generate meaningful returns and may not keep up with inflation.

Cash vs market-based investments

Holding cash can be a safe and familiar option, but it is important to understand the risks and benefits when compared to market-based investments.

Cash Investments

Cash investments, or cash equivalents, are short-term, highly liquid investments that earn interest. They can be converted to cash quickly and easily with little to no loss of value. Examples include money market accounts, certificates of deposit (CDs), US Treasury bills, and money market mutual funds. These investments provide stability and emergency funds, and are ideal for short-term savings.

Market-Based Investments

Market-based investments, such as stocks and bonds, have historically outperformed savings accounts and offered higher returns over time. While more volatile, these investments have the potential to generate higher returns and keep up with inflation.

Key Differences

The main advantage of cash investments is their low risk and liquidity. Cash investments are stable and easily accessible, making them ideal for emergency funds or short-term savings. However, they often provide lower returns and may not keep up with inflation, resulting in a loss of purchasing power over time.

On the other hand, market-based investments like stocks offer the potential for higher returns and better inflation protection. However, they come with higher risk and volatility, and may not be suitable for short-term savings or emergency funds.

Strategies for Holding Cash Value

When deciding between cash and market-based investments, it is important to consider your financial goals, risk tolerance, and time horizon. A general rule of thumb is to hold between 2% and 10% of your portfolio in cash and cash equivalents, but this may vary depending on individual circumstances.

Cash investments can provide stability and liquidity, especially for retirees or those with a lower risk tolerance. Market-based investments, on the other hand, offer higher return potential and better inflation protection, making them suitable for long-term goals.

To optimize your investment strategy, consider diversifying your portfolio to include both cash and market-based investments. This allows you to balance stability and return potential while managing risk. Additionally, consider seeking advice from a financial professional to determine the best approach for your specific needs and goals.

How to grow your cash savings

Holding cash can be a safe and liquid asset, but it may not be the best option for growing your savings. Here are some ways to grow your cash savings:

Invest in a Mutual Fund

The type of mutual fund you invest in will depend on factors such as your retirement timeline, tolerance for risk, and financial goals. Mutual funds have historically outperformed savings accounts, with some averaging a return of more than 5% over the last 10 years.

Dollar-Cost Averaging

If you have a large amount of cash and are unsure about investing it all at once, dollar-cost averaging can be a good strategy. This involves investing a small amount of money regularly, rather than a lump sum, to reduce short-term risk and build your portfolio over time.

Invest in the Stock Market

While the stock market can be volatile, historically, stock prices have trended upward over the long term. It is generally more profitable to remain invested in stocks, even during market downturns.

Diversify Your Portfolio

It is important to diversify your portfolio across a wide range of asset types and sectors. This helps to balance risk and return, as some investments will perform better than others at different times.

Ready-Made Investments

If you are unsure how to achieve the right balance of investments, you may want to consider a ready-made investment fund. These funds invest in a range of different assets, with a fund manager responsible for achieving the right balance.

Keep an Emergency Cash Buffer

While investing is a great way to grow your savings, it is still important to have some cash set aside for emergencies. Financial advisors often recommend keeping at least six months' worth of income in an easily accessible savings account.

Remember, when growing your cash savings, it is important to consider your financial goals, risk tolerance, and time horizon.

Frequently asked questions