Is Your Cash Position Right for You?

January 23, 2025

A 5% yield on safe money was the mantra retirees used to live by. For a decade and a half, it was an impossible feat, flying-in-the-face efforts to live on interest without touching principle. It nevertheless remained a holy grail spurring the expansion of investment vehicles with exotic strategies designed to meet that target (albeit with higher risk profiles than U.S. Treasuries).

Then, in 2022, the Federal Reserve went on an epic interest rate hiking campaign that brought 5% well into focus for the first time since 2007, which both inverted the yield curve and encouraged a major increase in cash as a holding for U.S. investors. The money market fund rates, which were relatively meaningless for so long, became a highly enticing vehicle for individuals wanting to enjoy portfolio stability after witnessing a historic bond bear market. What’s more, they could have their cake and eat it, too, because the best yields that provided the highest cash flow were on the short end of the curve. The “death of the 60/40 portfolio” was declared and cash became king again. Cash held on the balance sheet of U.S. investors has climbed to almost $7 trillion as of the end of 2024 according to a release by Investment Company Institute.

Now, we are in a declining rate cycle, and while the current rates for keeping cash in the money market can currently hover around 4%, the risk of further declining rates is more than theoretical — at the latest meeting of the Federal Open Market Committee (FOMC), the Chair of the Federal Reserve (Fed Chair) recently projected another two rate cuts in 2025, noted Charles Schwab in their December FOMC Recap. With cash currently still paying 4%, it’s challenging to feel excited about locking in longer term yields. There are good reasons to keep some cash in your portfolio with the advantage of getting paid pretty well. On the other hand, too much cash can lead to potentially devastating effects on overall portfolio performance, and more importantly, the ability to achieve your financial goals.

Are you holding too much cash? Here are some questions to consider: 

Will You Use This Money in the Next 18 Months to Two Years? 

If you need to spend some money on large projects, real estate or other investment commitments like private equity over the course of the next year, basic financial planning principles would support holding that money in cash or cash-like investments. This would allow you to maintain liquid cash or time maturities of those cash-like investments, such as certificate of deposits (CD) and Treasuries, with when they will be needed. Holding cash in this situation ensures that the assets are there when you need them and are not affected by market volatility.

Similarly, if you are retired or rely on your portfolio to supplement spending needs, you may consider creating a strategic cash bucket within your portfolio to support your spending regardless of market fluctuations. Holding cash to cover a year’s worth of spending provides flexibility and insulates that money from volatility. You could use other cash-like instruments to take it further in the event of a prolonged bear market. Ideally, this could look like keeping a year of spending in a money market account and another two years of spending in laddered Treasury Bills or CDs. Using the Treasuries or CDs for the next couple of years would allow you to maximize the length of time that you can receive that yield regardless of what happens with rates. This cash would be a critical component to your overall fixed income/bond allocation.

Are You Waiting for Market Opportunities?

If your answer is “yes,” then consider what that opportunity will look like and be willing to make the move once it presents itself. Also, consider the potential downfalls of trying to time the market. Cash has been on the sidelines waiting for opportunities since the longest bull market in history began after the shock of the Great Recession. Those who were waiting for a significant decline to warrant investing, unfortunately, missed out on the recovery.

While perfect market timing would yield the optimal result, it’s largely realistic only when backtested and not terribly great as a go-forward strategy. This is due to the need to perfectly time both when you get into the market and when you get out — which is challenging for even the most seasoned asset managers. The next best option to perfect timing is immediately investing, but dollar-cost averaging is a good compromise to that for someone with a large amount of cash to invest, as suggested in “Does Marketing Timing Work?” You may already be dollar-cost averaging in other areas, like 401(k) contributions, where your semi-weekly contributions get automatically invested into the market throughout the year. This strategy allows you to make the commitment to invest, without a big sticker shock if you invest at a time when the market pulls back. Added bonus: it also keeps you connected to the process of moving funds into the market, thereby helping to ensure that you don’t miss that opportunity if it does present itself along the way.

Keep in mind that having some cash strategically aside for opportunities is fine and is common among retail and institutional investors. However, if you have an amount that exceeds the suggested allocation for your risk tolerance, then it would be wise to think about getting that number more properly aligned, advises author of “How to Achieve Optimal Asset Allocation.” From there, you can use the cash that remains opportunistically as you see fit along the way.

Do You Hesitate to Use Traditional Fixed Income, Like Bonds, for Income?

In 2022, when the Federal Reserve embarked on a highly aggressive campaign to increase interest rates, the bond market reeled in a way that investors hadn’t experienced in decades, and it was the worst decline in a single year. While bonds are on a strong path to recovery, the 2022 experience has given many investors a pause about locking up their safe money in fixed income investments, but it’s important to understand what you may lose by taking that stance.

Cash historically has struggled to keep up with inflation. Even if bond prices declined, they continued to pay income aligned with their coupon rates, an advantage that cash does not have. As rates decrease, that cash will be paying less and less. This will leave investors with a steady account value but a loss of real value against inflation because of the decrease in spending power of those assets. A strategy that leverages bonds as needed to buffer volatility in your portfolio and provide income will hedge against that inflationary risk through the regular, fixed payments paid out by those bonds. Further, even if bond prices decline and when held to maturity, investors receive their full value back, barring default. For long term allocation to assets that buffer volatility into your portfolio and pay income at rates more competitive to cash over the long term, bonds are an important part of the equation.

Apart from bonds, there are other investment vehicles that pay income, including alternative investments, annuities and derivative products. Each comes with their own unique profile of risks and tradeoffs. These could also be considered as complements to a diversified portfolio in addition to bonds.

Key Takeaways

In summary, cash can be a valuable asset class in your portfolio when used correctly because of its ability to buffer volatility, its stable asset value to help cover near term expenses, and its ability to provide flexibility in finding market opportunities in portfolios that are otherwise fully invested. It’s important to know that too much cash can drag portfolio performance since it historically cannot keep up with returns in other asset classes, as outlined by MSF Fund Distributors. In turn, this could impact your ability to achieve your financial goals.

Keep in mind that cash holdings in an account are subject to limits on insurance against the failure of the bank that’s holding them under Federal Deposit Insurance Corporation (FDIC) and the brokerage firm that holds the cash under the Securities Investor Protection Corporation (SIPC).

If you need help reviewing your portfolio to ensure you have the right amount of cash for your needs, we’re here to help. Contact us today and we’ll devise strategies tailored to your portfolio’s growth.

Written by: Jullie Strippoli

©2025

Advisory services offered through Sowell Management, a Registered Investment Advisor.

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