How much cash should I hold and the dangers of holding too much (2024)

How much of your wealth do you hold in cash? And how much ofyour wealth should you hold in cash?

Two very important questions often with rather differentanswers. We will discuss the pros and cons of holding cash and what we consideris the sweet spot in how much you should hold in cash.

Whilst it’s often viewed as the ‘safe’ option, there arepotential dangers in hold too much or not enough.

First, the risk of not enough cash. If you don’t holdsufficient cash, you can create cash flow stresses when unexpected expenses oremergencies arise. The amount you should hold is dependent on your specific circ*mstances.In general, and subject to your particular situation, less than 3 months ofliving expenses is generally not enough. At the other end of the scale, anymore than 6 months’ worth of your cost of living expenses, or net income aftertax is too much. There are obviously exceptions to this and some cases where itis prudent to hold even 12 months’ worth, however, the norm is 3 to 6 months.To be sure you are in an adequate and appropriate position, we recommend you arrangea meeting with us and we can analyse your position and suggest what is anappropriate level for you.

The dangers of too much cash

When markets are volatile, it is easy to see why people mightchoose to hold large sums in cash. As it’s something we handle every day,whether physically or digitally, it can seem more tangible than other assets. However,cash does lose value and this is particularly true in the current low-interestclimate.

Interest rates have been at a historic low for more than adecade following the 2008 financial crisis. The European Central Bank officialinterest rate is actually negative 0.25%!

A low interest rate is good news for borrowers, but the lowinterest rate environment is not positive for savers. It means your savingslikely will not deliver the returns they once did, especially if you comparethe current rates to the pre-2008 rates of return on cash.

If you hold too much of your wealth in cash, you won’t beable to keep pace with inflation, meaning your purchasing power will go downand it will be more difficult for you to achieve your goals.

Inflation: Affecting the value of savings

The reason the value of cash savings falls in real terms isinflation. Each year the cost of living rises and if interest rates fail tokeep pace with this, your savings are gradually able to purchase less and less.

The European Central bank and the EU countries’ governmentsaim to keep inflation between 2-3% and in recent times have kept it lower thanthat. However, with the increase of cash injected into markets to stimulate theeconomies of Europe in response to the coronavirus pandemic, there is a riskthat inflation could increase in the short to medium term. If inflation goesup, your spending power goes down.

Year-to-year, the impact of inflation can seem relativelysmall. Yet, when you look at the impact over a longer period, it highlights thedanger of holding too much in cash. If you hold excess cash in your bankaccount at say 0.1% pa interest and inflation is 2.5%, you are in fact losing2.4% every year.

And if you look at inflation in terms of your long-term orretirement goals you can really see the impact. Here’s an example: if you areplanning on retiring in 25 years and think you need €3,000 income per month inretirement, when you take inflation into account, you will actually need doublethat, €6,000 per month!

When is cash right?

Whilst inflation does affect the spending power of cashsavings, there are times when it’s appropriate.

If you need ready access to savings cash accounts are oftensuitable, for example, as we mentioned above, having an emergency fund.

When you’re saving for short-term goals (those less thanfive years), a savings account should also be considered. Over short savingperiods, inflation won’t have as much of an impact and can preserve your wealthfor when you need it.

However, when setting money aside for long-term goals,investing in diversified growth focused assets aligned to your goals, your riskprofile and other impacting factors may be a better option that’s worthconsidering.

Investing: When should it be considered?

Investing savings means you have an opportunity to beat thepace of inflation with returns over the long term, thereby, preserving or increasingyour spending power.

However, investment returns can’t be guaranteed andshort-term volatility can reduce values, as recent markets have demonstrated.For this reason, investing as an alternative to cash should only be consideredif your goals are more than five years away. This provides an opportunity forinvestments to recover from potential dips in the market.

If you’d like to talk us about the balance of your assets,please contact us. Our goal is to align aspirations with financial decisions,helping you to strike the right balance.