What Percentage of My Long-Term Investments Should Be in Cash?
Many experts recommend keeping at least three to six months of living expenses in cash in an emergency fund that can be easily accessed in case of an unexpected setback such as a serious illness, injury, or job loss. But what about your long-term investments? How much—if any—should be in cash?
There’s no single answer that’s right for everyone, and recommendations vary based on who you ask. As long as you have a fully funded emergency fund, some experts don’t recommend keeping any long-term investments in cash, while others recommend a range of 2%-10%.
You’ll want to consider the following in determining the amount of your long-term investments to keep in cash:
Your Risk Tolerance
Risk tolerance is how comfortable you are with the possibility of losing some or all of your initial investment, and it can significantly influence how you choose to invest your money for the long term. If you’re an aggressive investor, you may be comfortable with a portfolio that consists almost entirely of stocks and other risky options that don’t include cash. But if the ups and downs of the market keep you awake at night, you may be better off with a more conservative approach.
Your age typically plays a significant role in how much risk you are comfortable with. If you’re young and just starting out with your investing, you may be fine with riskier investments because, should the investment not pan out as expected or you even incur a loss, you still have time to rebound. However, if you’re older and expect to need any returns on your investments in the near future, you’re probably going to be more risk adverse.
The key is to divide your portfolio into asset categories that create a risk profile you’re comfortable with. In general, asset categories perform differently under different market conditions. So, when the value of one type of investment increases, other types of assets likely won’t perform as well. Diversifying your portfolio among different asset classes can help smooth out the ups and downs of the market and minimize potential losses during a downturn.
How Much Time You Have
This consideration is about both how much time you have on individual investments and how much time you have to invest in general. As mentioned above, older investors—or even younger investors looking to live off of their investments soon—typically want to minimize their risk because they don’t have the luxury of waiting for investments to rebound or the time to recoup losses. So investing more in cash through vehicles like high-yield jumbo CDs (certificates of deposit) or high-yield savings accounts makes more sense. This aligns with a basic principle of investing, which is to gradually lessen your risk as you approach the date of when you’ll actually need to use your investment as income.
Some experts recommend being more aggressive if you have some time until you need your money because you have more time to recover potential losses if the stock market experiences a downturn. On the flip side, shifting your allocation toward more conservative options as you approach the time when you need to use the money is usually advised to help avoid large losses you may not be able to recoup.
Your Savings Goals
One of the challenges of saving for the future is earning a high enough return on your investment to keep pace with, or outpace, inflation so your investment isn’t worth less tomorrow than it is today. The trouble with cash investments is that they typically don’t keep up with inflation. So it’s important to think about how much you want to have saved by the time you need your money and allocate your investments in a way that will allow you to achieve those goals while also managing your risk.
Pros and Cons of Cash Investments
Even if you’re comfortable with an aggressive investment portfolio, there are benefits to keeping some of your long-term investments in cash. First, you’ll have cash on hand during a market downturn to take advantage of cheap investment opportunities that may come your way. If you’ve got some cash on the sidelines, you have available capital to buy stocks, real estate, and other types of investments. Plus, having some cash reserves can give you the peace of mind you need to stick with your investment strategy during a market decline, so you’ll be less likely to make decisions you’ll later regret.
The challenge with putting long-term investments in cash is that, if too much of your portfolio is in cash, inflation could erode your earnings. If you decide to keep some of your investments in cash, make sure you’ll still be able to achieve your long-term savings goals.
To find the asset allocation strategy that’s right for you, consider talking to a professional who can assess your current financial situation, investment goals, and risk tolerance in order to help you develop a strategy you’re comfortable with. While you’re deciding how you want to invest your nest egg for the future, consider putting it in a high-yield certificate of deposit (CD). Your potential returns may not be as lucrative as they could be with other riskier investments, but you’ll likely earn more interest than you would with a traditional savings account while you decide on a more long-term investment strategy.