Cash
The original investment
Before bitcoin, before stocks, back in the day, people just had cash. It’s basically the original investment (along with like beaver pelts or woolly mammoth tusks or something - I don’t know clearly I am just making this up).
Most people don’t think of cash as an investment option. Reason being, it doesn’t create any return on its own (or very little return when it sits in a bank account). People also like to joke about bad strategic choices like putting all your cash under the mattress instead of into “real” investments like stocks or bonds.
Recently, I’ve even read a few quotes by well-known investors along the lines of “cash is trash.” I guess if you’re managing a few billion dollars, it’s easy to make fun of cash but, for the rest of us that don’t have a few billion in our investment accounts, I have some other thoughts.
Personally, I think cash is great - I’d certainly prefer having cash to nothing at all! There are a few reasons cash is super important to my personal finance philosophy:
Cash is fundamental - you can’t even think about investing until you have cash. You need to first make money somehow and then spend less than you make to have the excess cash to even start investing. This sounds simple but so many people never even get past this step of spending less than they earn.
Cash is safety - if all of your money is in the market, you may need to sell at a really unfortunate time. For example, the market crashes due to a bad economy and you lose your job; you need money and sell your investments for a loss. Oh, and the likelihood of a bad individual financial situation is most likely to occur in precisely this scenario when the market is down. That’s stressful. If you have a safety buffer of cash, it’s a lot easier to ride out inevitable market turbulence.
Cash provides options - if all of your money is invested, then you are just riding whatever market wave is occurring. If you have some cash, you can strategically buy certain investments or dips when things are weak. While you can also do this by selling one investment for another, having a little more cash provides the liquidity needed to make quick decisions.
These are just some quick thoughts on why I think cash isn’t such a bad guy after all. This isn’t to say people should hold a ton of cash instead of typical investments like stocks or bonds - it’s different for everyone depending on risk tolerance preferences.
I do believe though that the absolute first thing people should do though is create enough of a cash buffer to match an average three to six months of expenses. Life is unpredictable and it’s important to sleep well at night - knowing there is always a safe pile for “just in case” that won’t swing up and down with the market is really helpful for that.
For some people, three months of expenses is a huge portion of their total net worth. For others, it’s less. Over time, with good saving habits and sound investments, it’ll become a smaller percentage of a personal portfolio and can act as a metric for a successful saving strategy.
In the next post, I’ll show the power of cash as an investment using the return-to-risk framework. That’ll be more quantitative than the thoughts above and show how powerful cash can be when it comes to portfolio design.
Cash is low risk, but I view opportunity cost as a significant trade-off. I like point #2 when you mention many people may need access to their investment accounts during times of economic downturn. This is where I lean towards keeping 6-12 months of expenses (regardless of total net worth) in liquid assets. This should help weather individual and economic challenges and allow for more creative solutions. All other "cash" should be allocated to more lucrative investments depending on each individual's plan (some short term, some long term allocation).