How much cash should I have in my portfolio?

What does it mean to keep money "in cash"?

First, what is cash? Cash can take many forms, including money held in your bank account or wallet. Additionally, there are cash investments (also known as cash equivalents), which are a type of short-term investment product that earns interest.

In that sense, we define "cash" as a readily available short-term financial instrument with high liquidity, minimal or negligible market risk, and a maturity period of less than 3 months.

How do time, funding level, and risk affect investing decisions?

Now that we've defined what cash is, it's important to understand how your time horizon, funding levels, and risk tolerance can influence your decision to hold cash investments.

Time horizon refers to the length of time you plan to hold your investments before you'll need to access the money. Funding level assesses how your existing assets are currently meeting your financial needs. Risk tolerance is the degree of variability in investment returns you're willing to withstand. Generally, taking more risk increases your potential for higher returns.

By evaluating these 3 critical elements, you can tailor your cash holdings to suit your unique financial situation and goals, helping you maintain the right balance between liquidity, risk, and return.

As the chart shows, cash might play a significant role in a portfolio aimed at wealth preservation, while a growth-oriented portfolio might see a reduced reliance on cash. Learn more about the research behind our framework for allocating to cash (PDF).

Here are 2 examples of investor profiles that highlight the roles cash might play based on differences in an investor's risk tolerance, time horizon, and funding levels.

These examples are for illustrative purposes only and are not a recommendation to buy or sell a particular security. They do not take into consideration your personal circumstances or other factors that may be important in making investment decisions.

What are the benefits and risks of investing in cash?

When deciding whether cash investments are right for you, it's important to consider the advantages and disadvantages.

Pros of holding cash:

• Stability: Cash investments are less prone to market fluctuations, providing a stable portfolio component.
• Risk and return: During periods when interest rates are high, saving strategies can yield relatively high returns for their low-risk nature.
• Accessibility: Cash is highly liquid, meaning it can be immediately accessed or converted into other forms of currency and doesn't require selling an investment.

Cons of holding cash:

• Lower long-term returns: Historically, cash investments yield much lower returns over the long term compared with stocks or bonds.
• Shortfall risk: The low returns associated with cash may limit growth potential, making it harder to achieve your goals.
• Inflation uncertainty: Cash is vulnerable to inflation risk, which means the purchasing power of money may decrease if inflation outpaces the interest earned on cash holdings, as it often has in the past.  

How much return can I expect to earn on cash investments?

Interest rates on cash and cash-equivalent investments typically vary depending on the type of investment and the current economic environment. We can also compare nominal returns, or the stated returns, against real returns adjusted to reflect the true purchasing power after inflation. Over the last 60 years, cash's real return has decreased over time. In fact, cash has only provided a positive real return in 4 of the last 20 years. Here, you can see the impact of inflation on cash returns.