Cash has been a popular investment these past few years. A lot of people worried about the stock and bond markets have fled to cash. There are two situations where cash can make sense. But in almost all other cases, you really should minimize your stash of cash.
Scenario 1: If you know you will need money within several years – a great example is college tuition for your 16-year-old – you should be mostly in cash or short-term bonds, which are pretty similar. You shouldn’t own a lot of stock, because you can’t wait for it to recover from a market decline. That’s also why a retiree should have more cash than a 25-year-old. The retiree will need a portion of her savings every year. The 25-year-old can probably wait for decades.
That leads to Scenario 2. There’s always a risk the 25-year-old will lose his job. So he should have an “emergency” fund, in cash, of about 6 months’ expenses, or whatever period is sufficient to find a new job.
But apart from those two important scenarios, holding cash is not optimal. Over the past 85 years, after inflation, cash has returned 0.5% annually. That compares to long-term government bonds at 2.5% annually and US stocks at 6.7% annually. The future may not look the same as the past. But if you can take a 20-year view, I believe a mix of stock and bonds will do a lot better than cash.
Ignoring inflation, you never “lose” money in cash. Even with inflation, you usually break even. That makes cash appealing, because the human psyche isn’t well-equipped to handle even short-term losses. We panic too easily. But beware. History suggests cash is a dead weight on your long-term investment returns.