Why Cash is King

During my net worth updates, one question that often comes along is why I hold so much cash.  I believe the rationale behind the question is that  under normal circumstances, cash could be put to work and grow instead of sitting in a “high” interest rate savings account that barely keeps up with inflation.  I also believe in the rationale of putting cash to work, especially putting cash towards bad debt.  However, I also believe in holding a stock pile of cash in case “something comes up”.

For as long as I can remember, I’ve been a saver.  I recall being 8 or 9 years old with my own bank account and enjoying watching the numbers in my bank book (remember those?) increase.  This behavior has continued throughout the years and now I get the same satisfaction from my net worth updates.

Back in my University days, I worked part time (sometimes full time hours) while participating in alternating academic and paid work terms.  With some frugal discipline, I came out ahead with some cash in my bank account.  I believe that the earlier that you start building cash savings, subsequent large purchases become more manageable, which reduces debt over the long term and ultimately starts a long term positive financial cycle.   But even if you weren’t an early saver, the next best time is now.  Here are some reasons why cash is king.

Cash Savings Gets you Ahead

In our case, cash savings from University allowed us to put a large down payment on our first house within a few months of graduation.  This resulted in lower payments and less interest paid to the bank over the term of the mortgage.  Combined with lower payments and renting out a portion of the home, it didn’t take long before our savings grew again.

A growing cash war chest gave us options.  We could pay down the house to save even more interest,  pay down consumer debt to increase our cash flow even further, or invest the proceeds in the stock/real estate market.  What did we choose?  We paid off a student loan followed by a car loan within a few years.

Within four years, we sold the two apartment to build a custom home for our growing family.  As the positive financial cycle momentum kept building, it eventually lead to paying off our new home mortgage in three years.

Cash Savings Gives you Opportunity

As mentioned, our expenses were very low while living in our two apartment home.  At the time, real estate was my focus so when there was an opportunity to purchase a relatively new home that was in great shape for a great price, I took advantage of it.  My article on buying foreclosures in Canada explained how I purchased a rental property via bank sale.  The catch was that in order to purchase a house from auction (in NL), the winning bidder needs to fork out a 10% down payment on the spot or within that business day.   As we have a tendency to build our cash reserve, we had enough for 10% to close the deal quickly.

You may have noticed that I’m a bit of a deal seeker and as it turns out,  I’m the same way when it comes to the investing as well.  Having a bit of dry powder (ie. cash) sitting in the sidelines can allow an investor to quickly take advantage of buying opportunities without having to sell a position first.

Cash Savings Reduces Stress

It may depend on temperament, but for us, having cash in our bank accounts give us a sense of security.  This comes back to the argument of emergency funds – should people hold cash or simply have a line of credit in case the worse happens.  We’ve discovered that when we needed things like a new hot water boiler, or a new fridge for an apartment,  going into debt would simply add to the situation.  Simply put, we prefer to pay cash (although we use a credit card to collect the points first) and stay out of debt where possible.

What are your thoughts about cash?  Do you try to keep a cash war chest?  Or do you deploy cash whenever possible?

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FT

FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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FT
7 years ago

@Just in Case, personally, I would take a large portion of your cash horde and pay down that mortgage.

101 Centavos
9 years ago

We were very heavy in cash in the last two years. For 2012, we’ve gotten more into div-paying equities.

SST
9 years ago

It’s now probably standard practice in the financial industry to sell the ‘10% Cash’ asset allocation. This is completely different than having an emergency fund, which is NOT for investing — it’s for emergencies.

The reason for this allocation is two-fold: 1. cash dampens a bit of the portfolio volatility, and 2. supreme liquidity (ie. margin calls, buying opportunities, etc).

These days I’m a fan of cash, but that’s only because the markets are filled with unreliable garbage and fraud (MFGlobal apparently loved cash too…just not their cash!).

As for the poster who’s deciding between paying off their mortgage or investing their cash…depends on what your mortgage rate is. For example, my rate is 2.2%, thus paying off my mortgage would guarantee me a 2.2% return (in simple terms). Invest if you think you can make more than that in the markets over the same period as your amortization.

Happy Festivus!

Andrew
9 years ago

Agree cash is king. You should always hold a portion of your overall portfolio in cash to capitalize on opportunities that come up.

KP
9 years ago

I work in an industry that booms and busts – Just today I found out my long term project is cancelled and my employment situation is uncertain again.

For this reason I have had a large cash emergency fund ~30k (or 8-9 months of expenses). However, I just moved a good chunk of that into a bond ETF; it’s still earmarked for some shorter (<5 years) savings goals and a general emergency fund. But since my expenses have dropped (by half when I got married), and will again in a year and a half when the mortgage is gone, I'm just more comfortable with the higher level of risk – it wouldn't affect anything if I lost 5% or so…

Joe S
9 years ago

I disagree. Above a minimum “emergency fund”, as well as a fund for buying opportunities (which can be substituted by credit), too much cash is a big problem. Inflation is pretty much a firm 3%, and the best cash can get you in a discount bank is 2% a year before taxes, which is more likely 1.3%. So cash loses 1.5-1.7% a year. This is like putting your money in expensive mutual funds rather than cost effective ETFs.

Keep cash for emergencies, keep credit lines fully available for buying opportunities, and invest the rest. The nominal value of the economy is growing by 5-6% a year (real GDP + inflation) and if you’re not invested, you’re losing out.

Just In Case
9 years ago

Good Job FT

I am 37 and single income family. I support my wife and two small children. I have ~85K in cash sitting idle in my savings account. I am well aware that it doesn’t meet inflation. But this cash amount gives me a sense of security and above peace of mind (priceless).I have no debt except my mortgage ~245K.

With monthly expenses @ $3500. I feel rain fund equivalent of 1 year expense is fair enough ($42,000). I have cushion for 2 year. I am not comfortable investing in stocks under current conditions. I tried buying rental property which was good learning experience but not worth the headache fixing things and chasing tenants for rent. Unless and until I find a right opportunity. I would like to hold onto this extra 45K. . I am two & half years into my 5 year fixed @ 3.55%. I am considering making some lumpsum mortgage payments (~25k) and RESP contributions (5k) before the year end

All input will be welcome

Steve @ Grocery Alerts
9 years ago

This is so important especially, when it comes to investing.

It takes discipline and room to make this work but I try to leave 10% of portfolio in cash for any buying opportunities. Whether it is stock or something else.

Mike Holman
9 years ago

I think if you get to the point where you are debt free, then there is nothing wrong with having a bit of extra cash.

MP3
9 years ago

Interesting question. I think it depends on your employment situation. I for example am employed by an organization whose leadership is elected and so technically I serve at the will of who is elected. Which means every three years I could end up unemployed. So I make sure I have in cash on hand at minimum 6 months of regular expenses. That can be stretched to one year of expenses by a) cutting back on regular expenses in the event of unemployment and b) having an income supplement like EI while looking for work.

I’ve never had to use it but as I get older, it will be harder for me to find comparable paying work so having the cushion will allow me the flexibility of not taking the first job that comes along.