With the dotcom bubble and the subprime crisis still fresh in our minds, it is understandable why so many investors continue to hold sizable cash positions in bank accounts or money markets. Unfortunately, this habit can be very hazardous to your long term financial goals.
Since 1926, one dollar invested in a 70% stock and 30% bond mix, rebalanced annually, would be worth $1,721. A dollar invested in 60% stock, 20% bonds and 20% cash would be worth $938. Due to compounding, the 20% cash position eliminated almost 50% of the growth.
A more meaningful example for individuals takes the same portfolios over the last 30 years. This time, a dollar in the 70/30 portfolio grew to $18.36, while a dollar in the 60/20/20 portfolio grew to $14.11.
If this doesn’t sound like much, consider how a 33% spending cut in retirement would feel.
There are times to hold cash, particularly if there are short to mid-term liquidity needs. But for most people, maintaining a large allocation of cash is more dangerous than safe.