Having too much cash is a unique problem that only a handful of individuals ever get to enjoy. With so many Americans living without savings or retirement accounts, it can feel good knowing that you’re not only making a lot of money and but also have plenty of it tucked away in savings. That said, even a high-earning individual with lots of cash on hand is not guaranteed a secure financial future. As much as money can be an asset, it has some drawbacks as an investment vehicle. Here is Why:
Cash Yields Negative Returns
Even though inflation for the dollar is relatively low in comparison to other currencies around the world, it will still have a negative effect on a net worth that is dominated by cash holdings. Where other asset classes typically rise along with inflation, cash does not. If you are sitting on a million dollars worth of cash, close to 2% of it’s purchasing power (roughly $20,000) will be lost within the next twelve months alone.
It Has a High Opportunity Cost
Aside from the negative effects of inflation, holding on to piles of cash also means you’re paying an opportunity cost of the loss of potential return you could be making from another investment. It was the French Economist Thomas Piketty who famously argued in his best-selling book Capital that within the free-market, over time, capital naturally clusters on its own. In other words, the spoils go to those who invest.
When Cash Is Important
Having lots of liquid cash is not all bad. In fact, almost every respected financial will tell you that keeping money in reserve or a “rainy day fund” is an absolute economic necessity. Life is full of unexpected events. Having a cushion that you can use in case of emergencies doesn’t only give you peace of mind but can also provide you with much needed financial flexibility in certain circumstances. That said, outside of an emergency fund or a reserve fund, choosing to invest your money in safe non-risky investments can yield much higher returns in the long run.