Let me paint a picture for you really quick. A man is sitting at his desk looking at his Scottrade account. He’s been noticing the volatile market swings and doesn’t know what to do with his money. He start sweating. He starts to wonder if he should place his money under his mattress instead.
Does this sound like you or someone you know? It’s an all too familiar story these days. After all, isn’t cash KING? Having that money in your hands feels great! Unfortunately you will never make money by just holding that cash.
So which is it? Is it safer to keep your money in cash right now or is it smarter to invest it and attempt to make a profit? Let’s dig in our heels and find out.
Benefits of Holding Cash
When the stock market is crashing, your cash stays safe, thus preventing unecessary losses. These market losses can be avoided because your money remains liquid and isn’t subject to market fluctuations.
Holding cash also has psychological benefits. What would you rather have: a dwindling retirement account of stocks or a pile of cash that you can visually see and use? For the short term, having that cash can give you peace of mind.
Negatives of Holding Cash
Unfortunately, there is this thing called inflation. I don’t care how good it feels to hold your money on your hands, inflation is going to slap your cash across the face. Don’t get fooled into thinking that just because your account value doesn’t go down that you’re not losing money. After you factor in inflation and tack on potential taxes, guess what? You could be effectively losing more than two percent a year.
Finally, have you ever heard of opportunity cost? It’s that phrase we were taught in college. In simple terms, it is the cost of foregoing something to buy or do something else. When you hold cash, you theoretically forego gains in the stock market. Although there is risk involved, there is also a potentially large payoff that you could miss. Just look at the last few years following the market crash of 2008. Stocks went on to post the two best years in history. Those who moved into cash missed out.
Making the Decision
So, comparing your two options, it seems that holding cash may or may not be your best option. For the short term thinker, cash makes sense. However, the implications for a long term investor are grim. If you have a long term horizon, you can take a look at the historical charts of the stock market in general and it’s easy to see that stocks move up and down, especially in the short-term. But look at the big picture and you’ll see that what happens year to year doesn’t mean as much when you’re covering the span of a few decades. Even more important to note is that you can be a conservative investor and still protect your money while making more than one or two percent on your cash.
This brings me to another point: you should never let your emotions drive your investment decisions. Too many people did that with the most recent stock market crash and look where that got them. Yes, they had cash and may have prevented further losses, but now they have missed out on the market gains since then. I actually fall in the opposite camp. If I have investments in the market and my stocks start to plummet, I don’t go to cash, I actually buy more of that stock. A majority of companies take hits and then come back with booms. Buy low and sell high is a winning strategy and has worked for me extremely well. When you sell after a crash and invest again when the market is going up you’re doing the opposite and selling low and buying high.
This debate has been beaten to a pulp over the years. When it comes down to it, one needs to look at their goals and desired retirement age. The closer you get to retirement, you might consider a larger chunk of your portfolio in cash. As a young person, the only cash I hold is my emergency fund. So, you can see how this depends on your personal situation. However, I recommend a buy and hold strategy for every type of investor out there. Avoid extra fees, and dollar cost average your way to retirement. It’s really that simple if you stick to it. Want proof? Take a look at how dollar-cost-averaging and diversified investing paid off during the so-called lost decade.
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About the Author: Jon the Saver is a personal finance writer at Free Money Wisdom. His mission is to help you succeed in your personal finance life. When Jon is not writing on personal finance, he spends time with his girlfriend, lifts iron at the gym, and plays Scrabble.