We’ve all heard the phrase “Cash is king.” And there’s something to be said for having a lot of cash: it gives you financial peace knowing you’ve got solid savings in your bank account, allows you to purchase things when they go on sale, and can help you weather a financial emergency like your car breaking down or an unexpected medical bill.
Additionally, it provides a lot of comfort when we experience a period of economic and stock market volatility, as we did in 2022. Yet you can actually have too much of a good thing—and that is especially true with your cash savings.
If you make the mistake of hoarding too much cash, it can not only lower your overall net worth, it may also derail your retirement goals if it isn’t appropriately planned for. In this post, we’ll discuss why inflation is hurting your cash savings, how much cash you really need, and how you can deploy your cash to pursue your financial goals.
Everyone knows that the cost of goods goes up over time, and we can all plan for that in our financial lives. Yet what happened in 2022 was more than just a slight change in prices. Inflation peaked at 9.1% in June, which was the highest it had been in 41 years.
While this hurt us at the gas pump, shopping for groceries, and buying holiday presents, it also harmed our cash accounts. Why is that? Because the average cash savings account doesn’t come close to matching the high inflation we experienced. In fact, the average savings rate is well below 1%, which means that for every dollar you have in cash, you are losing purchasing power, thus lowering what you can buy with your money.
If this trend continues, where inflation is significantly higher than what your cash generates in interest, then over a period of years or decades, that disparity could cripple your net worth and your odds of financial success.
While holding too much cash for too long can erode your purchasing power, I also don’t want you to skimp on what you need in your savings account. So how much should you have? There aren’t any one-size-fits-all answers to this question, but I do have some helpful tips.
Most of us have heard the rule of thumb that you need between 3 and 6 months of living expenses saved up for emergencies. I think that’s generally good advice, but that range is pretty wide, and there are other factors that will change how much you need to have saved. Here are some questions I like to ask to help answer that question:
In these types of considerations, if you share your finances with someone and you both have stable jobs where layoffs are quite low or even nonexistent, you might be more comfortable with an emergency fund closer to 3 months. But if you’re single in a 100% commission-based job where layoffs are frequent and you have hefty fixed expenses you can’t cut, then you might lean more toward a 6-month (or more) emergency fund.
Once you’ve got a comfortable amount of living expenses covered in your savings, the next thing to do is make sure you’re getting the best interest rate possible. It won’t keep up with inflation, but it can still be higher than the average savings rate discussed above. You can look at high-yield savings accounts, shorter-term CDs, or money market funds. These alternatives offer higher annual percentage yields (APYs) than traditional savings accounts.
So how do you keep up with, and even exceed, inflation? The short answer is that over the long term, equities have historically shown to produce the highest return. While 2022 wasn’t a great year for the stock market, long-term investors plan for the good and the bad. There’s too much volatility and uncertainty over the short term to anticipate which way stocks will go.
Yet over the long term, the results have been rewarding. Since 1950, the S&P 500 (the leading 500 companies in the U.S.) has averaged over 10.51%, including reinvesting dividends. Over that same period, inflation has averaged around 3.53%, which shows that a broadly diversified portfolio has been able to significantly outpace inflation over the long term.
That means that any excess cash in your savings account, as well as any cash sitting in investment accounts, may benefit from being invested in a variety of equity funds to improve your diversification, as well as increase your odds of long-term financial success.
Does the thought of figuring this all out on your own feel exhausting? Do you simply want to work with an expert you can trust to ensure you make all the right decisions with your finances? I’d love to see if I can help. To schedule an appointment, you can call 440-505-5704 or email jbrown@Wadvocate.com.
John Brown is a wealth advisor at Wealth Advocate Group, LLC, an independent, fee-based wealth management company. With over 10 years of experience in the financial industry and a background in accounting, John provides sophisticated and specialized services to his senior executive clients who need the expertise of someone well-versed in concentrated securities and restricted stock strategies, as well as the risk and tax burdens that come along with their compensation. John has a bachelor’s degree in accounting and financial management from Hillsdale College and is a CERTIFIED FINANCIAL PLANNER® professional. John is known for his thorough approach, often asking questions and bringing up details his clients have not considered. He strives to address every piece of his clients’ financial picture to make sure they are on the path toward their goals and financial confidence. In his spare time, John and his wife, Christina, enjoy traveling and staying active. You can often find him spending quality time with his friends and family. To learn more about John, connect with him on LinkedIn.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
