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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I agree with the idea of having a large safety cushion. I usually hold about $25,000 in cash and have a $50,000 LOC (that usually sits with no balance) for this purpose. However, looking for real estate bargains isn’t my thing, so I don’t have the same needs as you do for “dry powder”.

I like to keep 6 months of normal expenses in cash ($35K) at ING and/or Ally. Anything above that I like to invest somehow. I also have a $50K LOC (not used) for any truly extraordinary expenses.

I have always carried a “lot” of cash in my day to day account as I was taught to never, ever pay a bank fee or (god forbid!) an overdraft fee. I am only slightly less paranoid these days. As I choose when and how much to pay myself, I forecast my expenses and bill due dates, and then pay myself enough to cover my bills that month, keeping $1000 extra … just because. This helps me minimize taxes every April as well.

I am self-employed, so 6 months cash cushion is reasonable to me. After 7 years of self-employment, my one and only unemployment was 2.5 months, which I chose to stretch to 3 upon a new contract.

Today I am a little above my 6 month target simply because I haven’t seen much to invest in that interests me (yet). But when I do it will all go out quickly.

Cash is king right now that markets have lowered again. If I had that cash I would be very tempted to put the whole thing right into the stock market. Especially if we go down another 5%. We could see that and I have some cash waiting for a nice e-series purchase.

I currently have close to 200k in cash… with wife’s 5k bonus and 12k tax refund yet to come… pay off mortgage or to invest it? Age old question….

I don’t hold usually hold cash. I have a 3-way secured line of credit split into 3 accounts:

1) Non-deductible interest
2) deductible interest for my wife
3) deductibe interest for myself

We bought our house 3 years ago and aggressively paid down the mortgage (paid off this past summer). During that time we had little cash savings.

Here’s why:
– we were focused on paying off the mortgage, once that was done our minimum living expenses would be greatly reduced anyway
– if an emergency came up, we could tap up to $50K on the non-deductible LOC, then instead of paying down the mortgate we’d switch to the LOC until it was clear again
– the $50K from that LOC should cover any reasonable emergency

No emergency that needed the LOC ever came up. We now sock most up money into investments, still no significant cash position. We save cash for home repairs/vacations, etc and we cash for investing, but don’t keep cash reserves. If a buying opportunity comes up and don’t have the cash, we just pull on the investment LOCs for that, then pay the LOC down, etc.

Half our income goes to investing, at any moment we can stop investing and start hoarding cash if somethign happens (apocalyse, etc.)

@robb_stark question, if you had a fully paid off house, would you take out a 200,000 loan against it to invest with?

Why not?

While I can appreciate having cash on hand, it does seem you keep a pretty large sum – more than most!

I don’t keep much cash on hand, just a few thousand dollars at most. I prefer to deploy my cash towards our savings/investing goals and reducing our mortgage.

For some reason I don’t like the idea of cash just sitting there when I have so many uses for it.

Good post.

I agree with having some cash as a safety net, but $10,000 is our safety zone.

We’re not doing as well as we should – we only have $2,000 in ours right now. Hopefully we can get that to at least $5,000 by the end of 2012. That will be one of our goals.

I don’t know about holding more than $10,000 cash. I can see why folks do it though. I think I’d rather have any excess cash a) going on our mortgage or b) invested, since I’m losing valuable compounding power, dividend or distribution reinvestments with having my money sitting around.

I have a line of credit mortgage, so all my extra cash goes in there. I can get it back at any time and while I’m not using it, it saves me from having to pay interest on that amount of the mortgage.

The old me would have invested every penny into a highly leveraged investment.

During the last recession, I learned to increase my cash reserve significantly. I found myself in a bind where I had a hard time paying back my student debt, my rentals had a higher vacancy rate and my property prices had dropped, all while being laid off.

After going through this tough bout and repaying my student debt, I calculated that I would need 5-10%+ of my entire investment debt to bring me through the worst case scenario which could likely be the next recession. This amount will keep me afloat if I lose my job for one year, have 40% vacancy in my rentals, have significant damage to one of my properties (cover double the detucible) and house prices drop to the point where I have zero equity left. This cash should not be kept in a LoC that a bank can close and should not be kept in a liquid investment that fluctuate with a recession.

Any extra cash that I will accumulate on top of my emergency fund will likely go to the next investment opportunity.

Having ample cash on hand gives one tons of “options”. Thats what I like about it. And the sleep well at night factor.

I’m a huge fan of cash savings for all the reasons you’ve already mentioned (especially the part about being able to have cash on hand for opportunities to buy stocks etc. at low prices).

Unfortunately my emergency fund has withered away and I’ve been trying to build it up again. I would be happy if it were above >$10,000 like Mark as well, but currently it’s around $2000.

I’m also a huge fan of cash flow- I wonder which one is more “king”? Cash or cashflow? :)

I think it would be ‘cash’ itself in my books lol…

Good post, thanks FT.

The usefulness of cash has very recently been made clear to me:
The Ottawa company that I left only 6 months ago just laid off all staff (yes, the week before Christmas). I was wise/lucky to have left beforehand, but it really underscores the value of a significant cash reserve.

The baseline for our emergency fund is going to go from $5000 to $12,000 after income taxes this year. Even $12,000 seems low now…

No mortgage or debt payments so cash sits in the 20-25K range, self employed so need some cash to cover tax bill.

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.

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.

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.

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

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.

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…

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

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!

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

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