Excess cash: the financial junk food risking your economic health

Tyler Kert
Tamarack Wealth Management

Cash is like junk food. It’s easy to access. It’s right down the street. It makes you feel good. In moderation, it’s not that bad. But too much junk food can have a detrimental effect on your health.

Similarly, too much cash can be unhealthy for your financial position. A good rule of thumb is saving 3-6 months of expenses in an emergency fund. If you’re carrying significantly more cash than that, you should consider some alternatives.

In November of last year, the Wall Street Journal reported a record $5.7 trillion sitting in Money-Market Funds. A Money-Market fund is a mutual fund that invests in short-term debt and cash equivalents. Why are Money-Market funds hitting new highs? It can be largely attributed to a combination of market uncertainty and increased yields for these short-term, liquid investments. 

2022 was a rocky year for the financial markets. The Dow lost nearly 9%. The S&P 500 plummeted over 18%, and the Nasdaq lost an astonishing 33.1%. Now, let’s be honest: down years or corrections in the stock market are inevitable. The market will go up and down. Volatility is a part of the game. But traditionally, when stocks are losing value, investors depend on bonds to maintain some stability. Unfortunately, the drastic increases in interest rates resulted in the opposite. CNBC published an article on January 7, 2023, titled, “2022 was the worst-ever year for U.S. bonds”. That just about sums up the bond market performance. In the article, Edward McQuarrie, a professor emeritus at Santa Clara who studies historical investment returns, was quoted saying, “Even if you go back 250 years, you can’t find a worse year than 2022.” So what we ended up with was a really rough year all around for investment portfolios. The stage was set for high-yield savings accounts and money market mutual funds.

After getting hammered in 2022, many investors jumped ship. Others decided to switch up their strategy. After all, why risk more money in the stock market when you can get up to 5% guaranteed? At least, that was the consensus among many. For those who are currently in this position and are enjoying the “guaranteed” 5% yields, there is some cause for concern. 

The thing that many investors don’t realize is that cash is not a risk-free investment. One significant risk of holding cash is the erosion of purchasing power due to inflation. Inflation means a dollar today is worth more than a dollar next month. Over time, the value of money decreases as prices rise. Inflation has historically averaged around 2-3% annually, but in 2022, inflation was 8%! 

Opportunity cost is another risk of holding cash or investing in money market funds. When you hold cash, you’re forced to miss out on potential returns that could be generated by investing in stocks, bonds, or real estate. While these investments carry their own risks, they also offer the potential for higher returns over the long term.

Lastly, if history is any indication, money market funds are not going to be paying these high yields forever. In an article titled, “Not All Money-Market Funds Pay the Same,” published February 2, 2024, the Wall Street Journal explained that while the median money-market fund returned 4.2% over the past year, the average annualized rate was 0.49% over the 10 years before 2022.

Clearly, too much exposure to cash and money market funds can present a problem. What is the solution to your cash problem? Well, it depends. That answer is different for everyone. But you can answer a couple of other questions to narrow it down. The first big question is, “What is your timeframe?” Are you putting down $50,000 on a house in six months? If so, then leave that money in the money market fund. Are you going to retire in six months? Take that money out of the money market fund and put it somewhere else.

In retirement, you should be looking for two things: guaranteed income and upside exposure. You need guaranteed income to make sure that you are going to be able to keep paying your bills and covering those non-negotiable expenses. Once you have the non-negotiable expenses covered, shift to upside exposure for the long-term growth of your portfolio. Guarantees and growth are the goal. A money market mutual fund offers neither. The interest rate isn’t guaranteed. It could go down tomorrow. Also, there is no upside potential. You will never get an 8% return on a 4.8% money market fund. 

Finally, everyone has a unique financial situation. There is no one-size-fits-all. If you’re not sure what to do with your cash, I would recommend sitting down and figuring out your goals. Once you know where you are going, you can build a plan that will get you there. If assistance is needed, I would highly recommend partnering with a financial professional who has the expertise needed to help you ask and answer the right questions. A good financial plan will consider the tax implications of every financial decision you make. Don’t delay! A financial plan can be the roadmap you need to take that overabundance of cash and reposition it to achieve your goals.

Tyler Kert, a licensed financial advisor and CPA, provides financial planning and tax consulting services at Tamarack Wealth Management in Cashmere, WA.