Is Cash the Safe Choice? Understanding the Risks of Holding Too Much

Many investors today face a question: what should they do with their cash as interest rates on savings accounts drop? While cash might feel safe, keeping too much of it can actually hurt your long-term financial goals. Right now, investors are holding a record $7.3 trillion in money market funds—a sign that many people are sitting on the sidelines.

Successful investing isn't about choosing between risky investments and cash. It's about finding the right mix of investments that match your goals. Cash is important for paying bills and handling emergencies, but holding more than you need can mean missing out on growth opportunities.

Over time, stocks and bonds have grown much faster than inflation

History shows that stocks and bonds have been powerful tools for building wealth. As the chart shows, while something that cost $1 in 1926 now costs $18, stocks and bonds have grown much more than that. This growth has happened despite market downturns, financial crises, and recessions over the past century.

Past performance doesn't guarantee future results, but this pattern shows how markets can recover. Even recent high inflation has been small compared to the returns from a mix of stocks and bonds. Over time, earning returns above inflation—even modest ones—can create significant wealth.

Cash does have its place. You need it for upcoming expenses and emergencies. For example, if you're buying a home soon or paying tuition next year, you'll want that money in cash. An emergency fund is also important for unexpected costs like medical bills or job loss.

Too much cash loses value over time

Problems arise when you hold more cash than you need for these purposes. This has been common recently because of market uncertainty and high interest rates on savings accounts. When cash pays high interest, it can seem like a safe way to earn income. However, there are two hidden costs.

The first hidden cost is inflation—the rising cost of goods and services. Even when savings accounts seem to pay decent interest, they often don't keep up with inflation. The chart shows that after adjusting for inflation, cash has actually lost value during most of the past two decades.

The second hidden cost is that interest rates on cash aren't locked in. Rates on savings accounts and money market funds can change at any time. While some accounts offer attractive starting rates, these rates can drop quickly. If the Federal Reserve continues cutting rates as expected, the interest you earn on cash could fall below inflation.

This is different from longer-term bonds, where you can lock in a fixed interest rate for years. With a 10-year Treasury bond, for example, you know exactly what you'll earn regardless of what happens to interest rates. Stocks are uncertain in the short term, but investing for the long term has historically helped investors grow their money.

Record amounts of cash are sitting on the sidelines

The chart shows that money market funds now hold a record $7.3 trillion—nearly double what they held before the pandemic. This reflects both the appeal of higher short-term interest rates and investor caution about longer-term investments.

However, as interest rates fall, these cash holdings face challenges. Investors who moved money to cash when rates were high may now need to make difficult decisions. Many may eventually move back into stocks and bonds as cash becomes less attractive.

The best approach depends on your goals. One strategy is dollar-cost averaging, which means gradually moving cash into investments over time. This matters today because stock markets have been rising and bond yields remain attractive compared to history. While predicting interest rates is difficult, both stock and bond markets have become less volatile recently.

The bottom line? Cash is important for emergencies and near-term expenses, but holding too much can quietly hurt your long-term goals. For most investors, keeping some cash while staying invested in a diversified portfolio is the best path to financial success.

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