Please ensure Javascript is enabled for purposes of website accessibility

Do You Have Too Much Cash?

By Maurie Backman - Oct 2, 2017 at 8:06AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Believe it or not, there is such a thing as an overly funded savings account.

Most Americans are woefully behind on emergency savings, so much so that they're putting their immediate and long-term finances at risk. A frightening 57% of U.S. adults have less than $1,000 in the bank, which is considerably less than what the average household needs on hand for emergencies. Worse yet, 39% of Americans claim they have absolutely no savings at all.

But then there are those who have the opposite problem -- and admittedly, it's not the worst one to have. Whether it stems from an overly cautious attitude or a general fear of investing, many households have much more money than necessary in good old cash. In fact, it's estimated that Americans hold 58% of their investible assets in cash, according to just-released data from BlackRock. And while that's less dangerous than not having enough cash, it's a risky prospect in its own right.

Rubber-banded stacks of U.S. currency in varying denominations are stacked in a pile.

IMAGE SOURCE: GETTY IMAGES.

How much cash is too much?

The typical American household should aim to have anywhere from three to six months' worth of living expenses in the bank at all times, with the higher end of that range being more ideal than the lower end. The logic behind this goal is that you never know when you might lose your job, fall ill, or wind up in another scenario where you can't work for a period of time. Similarly, you never know when you might get hit with a colossal home repair or enormous medical bill. Without adequate savings, the consequences run the gamut from going into debt to losing your home to being forced into bankruptcy -- and none of those is what you want.

Furthermore, while that three- to six-month savings threshold is ideal for most people, in some situations, it does pay to aim higher. For example, if you're the sole breadwinner in a household with numerous dependents, your income is variable, or your job or industry is seasonal in nature, then you may want to aim for nine to 12 months' worth of expenses in savings. But socking away more than a year's worth of living costs could end up hurting you -- not so much immediately, but on a long-term basis.

Don't stunt your savings' growth

The problem with keeping so much money in cash is that current interest rates are rather pitiful. These days, you'll be lucky to snag a 1% return on your money if you keep it in a regular savings account. Even CD rates aren't great -- you might get 2%, but that's if you're willing to lock your money away for a five-year period.

The stock market, on the other hand, has historically delivered a roughly 9% average yearly return on investment. Even if the market underperforms during your investment window, if you maintain a stock-heavy portfolio for a decade or longer, there's a good chance you'll score a 7% average annual return over that period (keeping in mind that you'll have enough time to ride out market fluctuations). In other words, you'll earn 6% more each year with stocks than with cash. Not only that, but the money you make from stock investments in a traditional brokerage account is subject to capital gains taxes, whereas any interest you earn from a savings account is taxed at the less favorable ordinary income tax rate. Or, to put it another way, cash pays less, and gets taxed more.

So just how much of a difference in growth might you ultimately be looking at? The following table shows the extent to which your savings can compound depending on how much you put away each month, and the type of return you get on your money:

Monthly Savings Amount

Ending Balance After 30 Years: Cash (Assumes Average Annual 1% Return)

Monthly Savings Amount

Ending Balance After 30 Years: Stocks (Assumes Average Annual 7% Return)

$200

$83,500

$200

$226,700

$300

$125,200

$300

$340,000

$400

$167,000

$400

$453,400

$500

$208,700

$500

$566,800

$1,000

$417,400

$1,000

$1.133 million

Data source: CALCULATIONS BY AUTHOR.

All you really need to do is look at these numbers to understand the danger of keeping too much money in cash.

So where do you go from here? See how much money you currently have in savings, and if it's more than six to 12 months' worth of living expenses, put the remainder in stocks. The only exception is if you're planning to use that money for another purpose within the next seven years, such as making a down payment on a home. But if it's money you've accumulated to serve either as your personal safety net or eventual nest egg, and you don't have immediate plans for it, maximizing its growth will pay off in a very big way over time.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
323%
 
S&P 500 Returns
112%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/07/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.