I remember when I was a little kid walking into the bank with my mother to deposit my first birthday check. For months after my initial deposit, I would beg my mom take me back to the bank every week just to have the clerks show me my updated balance. It was fun seeing my birthday money grow at 6% a year. It grew and I didn’t need to do anything. That was then, this is now…
Cash doesn’t grow 6% by itself anymore
Right now, investors who leave money in cash aren’t rewarded for doing so. Record low interest rates mean that your money earns next to nothing. It’s hard to plan for financial goals when your money isn’t growing.
Factor in inflation as well and not only are investors not earning anything with cash, but their money is probably worth today less than it was a few months ago.
The role of cash in your portfolio
Don’t get me wrong – cash can and should be used as a strategic asset.
Frustrated with returns on cash, some investors are taking that money and fishing for returns in the stock market. That’s what the economists and Wall Street tycoons want us to do, but it’s probably not the smartest decision. Cash has its place in a portfolio. Whether it’s saving for a rainy day, keeping your money free for more immediate spending needs, or waiting to buy back into the stock market when it drops.
Cash trumps equities on many fronts:
- Liquidity – You can’t get more liquid than cash.
- Fixed value – You know exactly what your savings are worth.
- Simplicity – Anyone can open a savings account or deposit cash.
- Security – The United States normally protects savers’ deposits.
- Cheap – Saving and withdrawing using a deposit account is free.
Here’s some cash in action
We looked at the top 20% of our users (by performance), with account sizes between $100,000 and $500,000, to see how they positioned their portfolios during the past volatile investment year. It turns out the top 20%, on average, allocated 14.26% ($36,625) of their assets to cash.*
In a turbulent market, allocating more to cash definitely helped to soften the blow of big market drops. While it makes sense in theory, the numbers also demonstrate cash’s strategic role in portfolios. So, with this backdrop, what’s an investor to do to maximize his or her savings?
5 ways to improve your cash
Times are tough for investors but it’s always a good time to optimize your cash. Here are a few things you can do:
- Compare your brokerage firm’s interest rate: Cash sits in most brokerages in money market funds. Traditionally, these have paid investors more than savings accounts. Today, the interest rate is nearly zero. First I would check with my broker to see if they have more than one choice. If your brokerage doesn’t have any good alternatives, you can immediately begin earning more by moving your cash account to another firm.
- Stick to your savings plan: When I mean stick, I mean stickk. Stickk is a site developed by a professor at the Yale School of Management to help people set and stick to their goals. It uses both carrots and sticks — helping to motivate and steer you away from failing. Set a goal of saving a certain percentage more each month. You’ll work hard to ensure it happens.
- Juice your cash: Frustrated by low interest rates, financial firms have been introducing new products that try to improve upon low-paying money market funds. New investment products like the ones PIMCO introduced aim to help investors earn better yields on their money by extending the average maturity while still keeping the risk relatively low.
- Spend less on everything: While you can certainly improve on the return your lonely cash earns in your accounts, you can also improve your monthly cash balance by spending less. Optimize your spending according to the best times to buy something throughout the year.
- Get your kids onboard: I’ve created the National Bank of Dad for my kids based upon a book by the same name. As parents, we dole out allowances based upon completion of certain chores (they NEVER do enough). The cool part is that we offer to hang onto their money for them and pay them a fictitious interest rate (say, 3%). So, they can choose to spend or save. The results have been awesome and we use Famzoo to manage it all.
“How much cash should I have in my portfolio?”
Unfortunately, there’s no easy answer to this question. Asset allocation is a complex beast. Your cash allocation is determined by your goals, your risk tolerance, and several other factors. If you have an advisor, they can help guide you toward the answer. Unfortunately, this question is a lot harder to answer on your own.
Figuring out the percentage of cash you should have in your portfolio has been, and still is, a major pain point for individual investors who can’t afford a registered investment advisor. Luckily, SigFig will instantly show you your allocation and tell you whether you’re holding too much, or too little, in cash (based off your goals, risk tolerance, etc.).
