Head of Partnerships
Regardless of whether you’re just starting out in your career, or you’re on the fast track to an early retirement, effective cash management needs to be an essential part of your financial plan. Particularly in Asia, where saving is such an ingrained part of its culture, many people have too much cash in their overall personal portfolios. That’s right: Just as there’s such a thing as not having enough cash, there’s definitely such a thing as having too much cash.
Here, we’ll unpack the latter: How much is “too much” cash? And why is “too much cash” a bad thing?
Cash may appear to be liquid and safe, but the reality is that if you have too much of it and the cash you do have isn’t in the right vehicles, your cash isn’t safe.
That’s right— cash, when improperly managed, isn’t safe.
What we mean by that is that you’re actually losing money when excess cash isn’t in the right vehicles, because the purchasing power of cash inevitably decreases with inflation. And that’s why having “too much cash” is a bad thing.
Cash is an asset that, just like any other asset, must be managed wisely and intentionally. Because cash inherently doesn’t grow in value, you can maintain or grow its value only when you put it in instruments that enable it to do so.
Nominal returns (before deducting for inflation): Savings account: 1%, StashAway Simple™: 2.4%, and Invested: 6%. And Malaysia's average inflation rate: 2.1%
Think of it this way: Compound interest works in the other direction, too. The longer you have excessive cash just sitting there, the more money you’re losing to inflation.
Because cash loses its value over time, it’s important to understand exactly how much cash you should have and where you should keep it.
Ask yourself why you have the cash you do have. Every unit of cash you have should serve a specific purpose. The purpose of cash is to be accessible for short-term expected and unexpected events.
In your current account, or savings account, you should have just enough to cover your monthly expenses. This minimises the amount of cash that’s exposed to the teeth of inflation.
For your emergency fund and short-term goals, keep your money in a low-risk, liquid, interest-earning vehicle. This may be a high-yield savings account, money market fund, or other cash management vehicles that don’t lock up your funds. When you’re assessing where to put your emergency funds or cash reserved for your short-term goals, make sure that your entire balance is at least keeping up with inflation (Malaysia’s inflation rate for the last 10 years averaged 2.1%, but most savings accounts in Malaysia earn only about 1% on that full balance.)
Speaking of which, we recently launched a cash management portfolio, StashAway Simple™. It has a projected rate of 2.4% on any amount (seriously, any balance has that projected return), without the hassle of locking up your funds, investment requirements, credit cards, tiered earning structures, and whatever else the banks have come up with to make it painful to manage your cash.
If you’re risk-averse, you’re probably afraid of losing money. And, as we know, if you have too much cash, the value of your money is most definitely declining. Sure, your cash doesn’t have a huge downside (and this makes it inherently low-risk), but having too much cash does mean you’re unnecessarily writing a death sentence for that portion of your cash.
Just because you don’t see the absolute value of the cash decreasing in your account, the real value of your money is declining— cash accounts don’t show the change in purchasing power the way investment accounts show your returns. So you’re not going to see that you’re actually losing money. It’s like being in an investment that has an invisible ever-worsening negative return. Though cash itself isn’t an investment, it’s still an asset that you must manage intelligently as part of your financial plan.
If you consider yourself risk-averse, there are low-risk, medium-to-long-term investment options that can earn you more than what cash management solutions might.
And, our lowest-risk investment portfolio has earned about 11.1% since 20171. How? “Low risk” means that you’re not exposing yourself to a large downside— it doesn’t mean you’re not able to earn returns. Our investment framework, ERAA®, strategically and uniquely maximises returns within a given risk constraint. Your money should be accessible and low-risk, and that’s why we don’t have any lock-up periods.
Cash dividends that don’t get reinvested can cause cash allocations in portfolios to compound. At StashAway, we reinvest your cash dividends to make sure we’re making the most of your investments.
We also use fractional shares down to 0.0001 of a share to maximise the power of your cash. Most fund managers don’t do that. To be as efficient as possible with your investments, we target a 1% cash allocation for your portfolios.
Your cash management strategy is absolutely part of your long-term financial plan. Just as a successful long-term financial plan requires discipline not to overspend on your monthly budget, and not to tap into your emergency fund for non-emergencies (no matter how badly you think you need that vacation, it’s not an emergency), it also requires discipline not to liquidate your long-term investments unnecessarily.
Irrationally, people often “get in and out of the markets” when they feel uneasy about the markets or economy, or if they’re trying to lock in gains when they think the markets are high. We already know that the likelihood of you re-entering at the ideal time is slim to none, usually ultimately resulting in lower potential returns.
But, there’s another problem with taking your money out of medium-to-long-term investments: It increases your cash allocation for an indefinite amount of time. That means that suddenly your money went from a long-term growth strategy to most definitely not earning anything. Plus, when are you going to go back in? Right away? In a year from now? Who knows! You could be waiting months, missing out on the markets’ opportunities, and losing to inflation.
1As at 30 April 2020 in MYR terms