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Daily Capital

How Excess Cash Can Hinder Your Portfolio — Even in Retirement

Key Findings

  • Higher-income investors ($200,000+) were almost three times more likely than less-affluent investors to say they became increasingly bullish in 2020 and added stocks to their portfolio.
  • They were also more likely to report a “significant” increase in the value of their portfolio during the pandemic compared with investors who have lower income.
  • On average, portfolios of surveyed retirees and soon-to-be retirees were made up of 26% cash.

 

There’s a common saying that cash is king – but this isn’t necessarily true when it comes to your portfolio and retirement goals.

People tend to like cash because it can feel safe. However, over the long term, it is anything but a safe place to keep your investments.

For those nearing retirement, allocating excess cash is still an important consideration. Retirement-age individuals may be skewing too conservative, according to a recent survey by Personal Capital and Kiplinger Personal Finance.

The asset allocation of investors remains conservative across genders and ages and regardless of whether investors are retired or not.

On average, portfolios of surveyed retirees and soon-to-be retirees were made up of:

  • 35% stocks
  • 26% cash
  • 15% bonds
  • 9% real estate
  • 15% other

Higher-income investors ($200,000+) were almost three times more likely than less-affluent investors to say they became increasingly bullish in 2020 and added stocks to their portfolio.

They were also more likely to report a “significant” increase in the value of their portfolio during the pandemic compared with investors who have lower income.

Why Do People Hold onto Cash?

Oftentimes, investors hoard cash when they are nervous about market volatility and uncertainty.

Some older investors who haven’t yet invested cash may also feel like they have missed the boat and don’t feel comfortable investing it in their golden years.

But the truth is, if you want your financial strategy to sustain you for the rest of your life, cash is likely going to do more harm than good. For reference, a dollar in 1980 is worth about 30 cents today.

How to Use Cash to Your Advantage

That being said, cash isn’t all bad; it has a place in any strategy.

That place, however, should be for any short-to-mid-term liquidity needs. We generally recommend that you keep an emergency fund of three-to-six months of expenses along with cash for any larger purchases you have planned in the next 18-24 months.

One way to be strategic about your emergency fund is to be disciplined about it. For example, if you spend $100,000 per year, you will want to have somewhere between $25,000 and $50,000 in cash reserves that you don’t touch, unless it’s a true emergency. Once you hit the maximum amount you’ve set for yourself in those reserves, then commit to putting any excess over it to work in a diversified investment portfolio. This way, you likely won’t end up with so much cash that it actually works against you.

In addition, you will likely want to keep cash for any big expenses or purchases that may be coming down the pike in the next 12-18 months, such as a big family event or a home renovation project. You can use Personal Capital’s free Retirement Planner to plan for spending in retirement.

Why Cash is Bad for Your Portfolio

Cash might give you a sense of security when you are worried about market uncertainty, but believing cash is a good long-term investment is a mistake.

By holding too much cash, you are essentially losing money to inflation every year.

Read More: How to Manage Inflation

The chart below compares the long-term historical performance of a variety of asset class returns. Note that cash ranks the lowest.

Image 1*

How to Invest Your Cash

When allocating cash, one of the most difficult decisions is choosing the right investments. There’s no one right answer, but there are a few factors to consider to help you choose the right investments for you:

  • Time horizon: Your time horizon is the number of years (or months) before you expect to use your investments. In the case of retirement funds, your time horizon is your life expectancy, as the assets must continue to work after you retire in order to support you. In general, the longer your time horizon, the more aggressive you can afford to be with your investments.
  • Diversification: Diversification is a critical component of investing. The general concept is that you spread your money across many assets, both across and within asset classes. The more diversified you are, the less the performance of a single investment will impact your entire portfolio.
  • Risk tolerance: Your risk tolerance is how comfortable you are with risk. Investors with a higher risk tolerance are comfortable experiencing greater volatility in their portfolio in exchange for a higher potential reward, while those who are more risk-averse will accept a lower potential return in exchange for lower volatility and variance in returns.

The Bottom Line

There are times to hold cash, specifically for short-term purchases and emergencies.

But if you’re trying to grow your money over time, even in retirement, there’s almost no reason to be in excess cash. For most people, maintaining a large allocation of cash is simply a guaranteed loss over time.

Methodology

The Kiplinger-Personal Capital national poll on The Impact of the Pandemic on Retiree Confidence was conducted June 17-24, 2021, with 772 respondents. The survey has a margin of error of +/- 3.52%. Respondents were screened for age (40 and older), retirement status (fully or partially retired, or plan to retire within five years), and net worth (at least $100,000).

*Image 1 data sources: Ibbotson Associates, MSCI, Standard & Poor’s, World Gold Council, BP.com, US Energy Information Administration, Robert Shiller Online, MIT Center For Real Estate, Yahoo Finance. Calculations are based on the long-term historical performance of asset classes using a combination of indexes and ETFs as proxies: S&P 500, MSCI EAFE and MSCI ACWI ex-US, 10 Year U.S. Treasuries, S&P/Citigroup International Treasury Bond Ex-US and 30 Day T-Bills, as well as IEF, IGOV, VNQ, IAU, and DBC. Prior to 2007, the Alternative asset class is represented by a hypothetical index of 50% real estate and a 50% gold/oil combination. Each year thereafter it is comprised of 50% real estate and a 50% blend of diversified commodities and gold ETFs. Portfolio standard deviation, correlation, and expected returns are based on average annual performance included in source data: domestic equities since 1926, international equities since 1970, domestic fixed income since 1926, international fixed income since 2002, alternatives since 1970, and cash since 1926.

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. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Michelle Brownstein is the Senior Vice President of the Private Client Group at Personal Capital. She is a Certified Financial Planner with a wide range of Investment Management experience.
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