My mother hosted a dinner party a few nights ago, where I got to catch up with Alice, an old family friend. Knowing that I am a financial advisor, she told me about a co-worker who was buying a house and was putting a sizable amount down. “How is she able to do that?” Alice exclaimed to me. “We make and save the same amount of money!”
I asked some probing questions and learned that my friend had been saving her money in a savings account while her co-worker was in diversified mutual funds. Hearing this, my heart broke for my friend. She thought she had done everything right but had unknowingly fallen into what I think of as “the cash trap.” Like many consumers, Alice had been lured by the promise of risk-free interest payments offered by typical savings accounts. But her cash had not worked nearly as hard as it could have for her.
You Can Have Too Much Cash
While I absolutely think that some cash is important to have (three to six months of living expenses works for most people), having too much cash can severely undermine your financial goals. There’s one major issue with keeping your wealth in cash that cannot be overstated:
Cash actually loses value!
But wait, you ask, if you are earning money via interest, how could you actually be losing money at the same time? In a word, inflation. If inflation is 3% and your cash is earning interest at 1%, then you are actually losing 2% a year. Your account balance doesn’t go down, but your purchasing power actually declines. That means that each year, the goods and services that you buy get more and more expensive, and your cash can’t keep up.
Put Your Money to Work
Cash is great for an emergency fund and for short-term goals where you cannot accept any degree of market risk. If you have any more than that amount in cash, it’s time to talk to your advisor. Cash is lazy. Isn’t it time you put that money to work?
