A question I’m often asked by readers is why I keep such a high amount of cash savings on the side. Isn’t it better to deploy all my available cash and enjoy the market ride up while also pushing my dividend income higher? While my answer generally would be yes, the situation isn’t always so simple. As someone looking to reach financial freedom should you hold on to large pockets of idle cash?
It’s true that on top of my rather large emergency fund of €8,000 I also keep a savings account on the side with about €18,000 in it. As you can see in my last net worth report that means about 44% of my portfolio is purely in cash. This money accumulates at a rather rapid 3.15% considering the low interest rates in today’s market. Many of you have asked how and where you can apply for this high-interest account too, but I’ve had to disappoint each and every single one of you.
The truth is that my savings account is a “First” life insurance account of Belgian insurer Ethias. My parents signed the contract before 2003 in my name and locked in a minimum interest rate of 3.15% for life. Yes, you read that right. Back then people believed a 3.15% interest rate would be sustainable for decades to come. In 2008 the financial crisis showed Ethias otherwise, even forcing the insurer to liquidate its First portfolio as demanded by the European Commission.
As such, the golden days of the First insurance accounts, back when they yielded over 6% every single year, are over. At the moment the eight year grace period stipulating that I can’t withdraw the money has passed, which basically turns the life insurance into a regular savings account: I can withdraw any amount of cash at any given time.
So why hold on to it then?
The answer lies in opportunity cost, which is the loss of potential gain from other alternatives when one alternative is chosen. The theory basically boils down to the fact that you can’t spend your money twice, so you have to stretch every Euro or Dollar as far as possible with a certain time frame in mind.
While the 3.15% yield of my First account isn’t bad in and of itself, it’s likely that more money is to be made in the stock market over the long-run. So by forgoing investing the cash in high-quality dividend income producing companies I’m losing out on the potential gain that option brings me. Even though that doesn’t make any sense from a rational perspective, there are some reasons why and situations in which incurring opportunity costs on oneself is acceptable.
Firstly, some people don’t like the idea of not having any cash on the side. Cash is the most liquid of asset classes and readily available when you need it. If you have a big expense coming up, your cash is there to be plunked down at a moment’s notice. Good luck doing that with less liquid assets like stocks or, even worse, real estate.
Ironically enough, people holding on to large cash deposits could very well do so because they believe the opportunity cost of investing right away is too high. When the financial markets are crashing down and stocks drop over 30%, they then deploy most of their cash, quite possibly making a much larger return than people who invested their cash when it became available. Even though I don’t agree with that strategy as timing the markets is a fool’s errand, many people are doing exactly that with today’s markets at all-time highs.
Secondly, a well-balanced portfolio, built on objective factors like age, location, and goals for example, might very well benefit from a cash holding. When you’re in your fifties looking to retire, you’ll have a completely different risk appetite than someone who is still accumulating wealth at 25 like myself. Does it make sense to go into your first year of retirement without any cash on the side? I doubt it.
You can already feel that everyone’s situation is different. As such, there’s no single good answer to the question whether you should hold on to your cash or not.
In the dividend growth investing community many of us are under the impression that deploying cash as soon and fast as possible is a good thing. Jason from Dividend Mantra has written numerable posts on why he prefers to build cash flow through dividend income instead of holding on to piles of cash. And I can’t say I disagree with him.
However, I prefer having a cash cushion to pick me up if something were to happen, both in my personal life or in the stock market. While I’m normally one of the most rational people you can find this side of the Atlantic, it’s an emotional response to an otherwise clear-cut issue. And that’s totally fine. You can rationalise an investing decision all you want, but when you’re not comfortable pursuing it to the fullest, your investing choice remains a bad one.
That’s why, apart from analysing the opportunity cost of holding on to your hard-earned cash or not, you should also ask yourself how either choice makes you feel.
As for myself, I’m keeping the cash savings, although I’ll be taking my money elsewhere by the end of this month. With the European commission forcing Ethias to sell off its First portfolio by the end of 2016, the insurer is now offering four times 2014’s interest as a buy-out incentive. That’s why you can expect a massive spike in income this month because the amount of bonus interest I’ll receive be upwards of €2,000.
Besides, I’ve got that money earmarked for a downpayment on a home sometime in the near future. I guess you could say I gladly pay the opportunity cost of not being invested in the market as to make sure that I have enough funds at my disposal to secure a mortgage when I need it. Again, that’s totally fine because it gives me peace of mind.
How about you? Do you hold on to large pockets of cash?