3 risks of too much cash
3 risks of too much cash
3 risks of too much cash
With higher cash yields, and seemingly greater-than normal uncertainty, many are tempted to keep a high allocation in cash or cash alternatives such as CDs or short-term Treasuries. We believe everyone should maintain a thoughtful emergency fund.
However, holding too much cash beyond emergency funds or short-term needs may be dangerous. At the highest level, it could lead to significantly less wealth over time.
Since 1928, U.S. Stocks have outperformed cash in 68% of the calendar years. Meanwhile, yields are likely to be significantly lower when existing CDs and short-term Treasuries mature, potentially making reinvesting challenging.1
High cash allocations are subject to:
- Lower returns
- Inflation risk
- Reinvestment risk
Bonds have moderately more risk than cash and tend to generate moderately more return. Stocks have meaningfully more volatility than cash and can generate meaningfully higher return. While the future is uncertain, blending stocks and bonds, especially if globally diversified, can help an investor to reduce risk and customize expected levels of return. Over time, extra returns — compared to cash alone —compound, which is very important. This chart shows the growth of $1 over the last 30 years, since 1992. An individual investing $10,000 in a portfolio of 60% stocks and 40% bonds would now have $154,000, while those sitting in cash would be left with just $19,300. Note that at various times in this period, cash was yielding well over 4%.
Growth of $1 — last 30 years (ending 2022)
Looking at bonds more specifically, in any given year it is true that bonds may lead or lag cash. However, it is very difficult to know which years those may be. Meanwhile, over more meaningful periods, bonds have a very strong track record of outperforming cash. For the five years ended in 2022, cash was better, but since 1930, bonds outperformed in over 80% of rolling five-year periods.
Five-year rolling return spread U.S. intermediate bonds vs. cash
The primary allure of cash is safety. While you won’t lose dollars holding cash, you can lose significant spending power. This chart shows the destructive impact of inflation on $1 put under the proverbial mattress in 1982. In this case, interest that could be earned on cash-like vehicles is not included, but the point is critical. Inflation is a greater destroyer of wealth than bear markets. Many assets, like equities, can benefit from increases in the money supply and resulting inflation. Cash is victimized.
Risk of high cash balance: Growth of $1
Despite the opportunity for higher returns and the risks of inflation, some may feel current yields on cash are good enough to support their goals. A potential pitfall can be reinvestment risk. Existing interest rates on cash-like instruments may not be available for long.
Most economists, and even most members of the Fed, expect short-term interest rates to decline starting in 2024. Especially if there is a recession, rate cuts may accelerate. The chart shows the three-month Treasury rate, a good proxy for cash yields, since 1990. We see that rates can fall just as fast — or faster — than they can rise.
If rates drop significantly, those with heavy cash allocations will be faced with a choice of again losing to inflation or reinvesting in stocks and bonds — quite likely at higher prices. Since 1928, stocks have had a positive return in 59% of months and 73% of years. Those are very difficult odds to bet against.
Three-month Treasury rate
The option to earn around 5% with no risk of losing dollars has obvious appeal, but there are hidden risks. For long-term assets, a properly constructed, diversified investment portfolio may be better, compared to cash alone and may provide an improvement in long-term wealth. If it provides peace of mind, a reasonable increase in cash allocation compared to lower rate environments can make sense, but we urge investors to be thoughtful about the potential consequences.
There are reasons to be nervous about short-term stock or bond movements. Historically, investors have been rewarded richly for assuming some calculated risk.
Get the scoop on your money.
Stay current on planning, saving, and investing for life.
1 Stern, NYU
The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. No part of this blog, nor the links contained therein is a solicitation or offer to sell securities. Compensation for freelance contributions not to exceed $1,250. Third-party data is obtained from sources believed to be reliable; however, Empower cannot guarantee the accuracy, timeliness, completeness or fitness of this data for any particular purpose. Third-party links are provided solely as a convenience and do not imply an affiliation, endorsement or approval by Empower of the contents on such third-party websites.
Certain sections of this blog may contain forward-looking statements that are based on our reasonable expectations, estimates, projections and assumptions. Past performance is not a guarantee of future return, nor is it indicative of future performance. Investing involves risk. The value of your investment will fluctuate and you may lose money.
Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it authorizes use of by individuals who successfully complete CFP Board's initial and ongoing certification requirements.
Advisory services are provided for a fee by Empower Advisory Group, LLC (“EAG”). EAG is a registered investment adviser with the Securities and Exchange Commission (“SEC”) and subsidiary of Empower Annuity Insurance Company of America. Registration does not imply a certain level of skill or training.