It may be time to rethink how much cash you’re holding in your portfolio.

 

Key takeaways

• Cash is a risk-free place to keep your savings. It can provide security and stability.
• If you hold onto too much cash for too long, you may miss opportunities to earn greater gains from other investments.
• Dollar-cost averaging is a way to move your cash into the market in small amounts at a regular pace.

They say cash is king. It’s a safe place to park your savings that can earn you a guaranteed income when placed in a savings account or traditional short-term GIC – clean, easy and risk-free. But for long-term investors, the charm of cash might be better likened an enchanting siren’s call, luring them off course.

What’s the problem with cash?

Short-term cash investments are often the best options for your near-term spending needs. However, challenges can arise when an excessive amount of cash finds its way into your long-term savings.

 

How so? Well, let’s first consider that stocks and bonds would be the common alternatives to cash for a long-term investor. Stocks and bonds carry more short-term risk than cash. But, over time, they are likely to outperform cash. In fact, if we compare a representative balanced portfolio – made up of stocks and bonds – to 1-year GICs, we find that even the worst 20-year return for the balanced portfolio (4.9%) was still better than the best 20-year return for GICs (4.7%).

 

Best, worst and average 20-year return

Annualized

 

How much might cash cost you as a long-term investor?

To illustrate the potential cost of cash, let’s imagine your goal is to save $500,000 over the next 20 years. We will compare two options to invest your savings:

• Invest in a balanced portfolio. We’ll assume that your money will grow 4.5% each year. This return is lower than what a balanced investor has historically earned.
• Hold your money in cash. We’ll assume that your money will grow 1.4% each year. This is lower than the long-term average, but is actually better than what cash investors have earned over the most recent 20 years.

The hidden cost of cash over 20-year period

Additional contributions required to reach savings goal when investing in a low return asset

 

 

Based on our data, to reach your savings goals of $500,000:

• If you invest in a balanced portfolio, you would need to contribute $305,000 over 20 years ($15,250 per year).
• If you keep your money in cash, you would need to save $431,000 over 20 years ($21,550 per year).
• The hidden cost of cash is $126,000 ($6,300 per year). This is because your cash investments don’t offer nearly as much growth potential as the balanced portfolio. So if you want to save $500,000 over the same time period, you would have to make larger contributions.
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