The Cash Dilemma: Why You Don’t Want to Hold Too Much or Too Little

There’s an old adage that cash is king, but in times of soaring inflation is it really a good idea to be holding significant amounts of cash?

Liquidity is important. Some would say more so than ever in tough economic times. None of us want to be caught without an easily accessed emergency fund in the event of an unexpected expense. However, there are reasons that holding large amounts of cash can work against you, and they apply in both good times and bad.

Why Hold Savings in Cash?

To be clear, we’re not talking about actual cash that you stash under your mattress here. We’re talking about funds held in cash rather than in stocks, bonds, property, or other investments. We’re generally talking about the money that you have available in regular bank accounts, that you can access quickly and easily. Most cash accounts can be accessed instantly, although some term savings accounts will penalize you if you make early withdrawals, or withdraw too frequently, so always check the terms and conditions of any cash account you open.

You need cash on hand because life happens, and some of life’s biggest expenses happen when you least expect them. That’s why so many people refer to their cash reserve as their emergency fund, and don’t like to touch it unless or until an emergency occurs. Having cash available when you really need it is vital. It stops you from having to sell other assets, perhaps during unfavorable market conditions, or borrow money, perhaps at a very high interest rate.

So Why Is It Bad to Hold Savings in Cash?

While we all need a cash reserve occasionally, there are definite disadvantages to holding too much of our net worth in cash. Here are some things to consider if you have a lot of cash in the bank right now.

Cash Quickly Loses Value in Real Terms

The interest rate on cash accounts is usually low, and over time, particularly in times of high inflation, you will be losing money in real terms. The math here is not hard. If you are earning 2% interest on your cash but inflation is at 6%, your cash is losing more value than it’s earning in interest. Other investments, such as the stock market or property, are far more likely to yield returns that match or exceed inflation, over time, with all other things being equal.

Holding Cash is Not Very Tax-Efficient

There are various ways of investing, whether it’s in property, in a retirement savings plan, or in a business, that might have a tax advantage for you. A lot depends on your individual circumstances so you should always seek customized advice from a financial professional, but the fact is that interest on cash accounts is generally subject to income tax, whereas other types of investment may allow you to minimize tax paid in any given year.

Large Amounts of Cash May Not Be Protected

In the US, The Federal Deposit Insurance Corporation (FDIC) insures deposits of up to $250,000. That’s $250,000 per person, per insured bank, for each account ownership category. In other countries it’s much lower (in the UK for example, it’s £85,000). While it’s unlikely that a bank will go bust, taking your savings with them, it is possible. It’s always best to keep your money diversified in different kinds of investments with different kinds of deposit protection.

There Are Many Investments That May Work Better for You Than Holding Cash

We’ve talked before about how not all investments are monetary. There may be various ways to invest your money that could pay off in the long-term, and we’re not just talking stocks and shares. People will, half-jokingly, suggest that spending all your money right now is a way to beat inflation, which is not generally the most responsible attitude. But it does of course depend what you spend it on.

Say you have a windfall that you can keep in cash or spend on education that will vastly increase your salary for the rest of your life? Spending it doesn’t seem so irresponsible now does it? That’s a very specific scenario, of course. The point is that because cash does lose value to inflation over time, there may be a case for spending it rather than saving it, if you’re buying something with a big future pay-off of some kind.

If you don’t have a lot of cash right now you may be thinking this advice doesn’t apply to you. Just be aware that things change. Many of us will get a cash injection at some point (say, following the sale of a business or property, or on taking possession of an inheritance), and suddenly the curse of ‘too much cash’ is a scenario you actually have to think about. If this is you right now, talk to a financial planner about how best to spread your investments.

Karen Banes is a freelance writer specializing in entrepreneurship, parenting and lifestyle. She writes articles, website content, ebooks and the occasional award winning short story. Her work has appeared in a range of publications both online and off, including The Washington Post, Life Info Magazine, Transitions Abroad, Brave New Traveler, Natural Parenting Group, and Copia Magazine. Learn More About Karen