Cash vs. Stocks: Where Should You Park Your Cash?

The continued warnings about an impending recession have made a lot of investors nervous. So much so that some Americans question whether they'd be better keeping their money in cash rather than investing it in the stock market. Particularly since some top high-yield savings accounts are paying APYs of around 5%.

But deciding how much to keep in cash and what to invest has more to do with your own financial situation than what the economy is doing or what rates savings accounts are paying.

Investing vs. saving

The difference between investing and saving is at the heart of the cash versus stocks debate. Both are important foundations for financial stability, but they play different roles in our financial tool kits.

• Saving: The idea is to keep your savings -- essentially cash -- in a relatively safe place, such as a savings account or a certificate of deposit. Safety is the name of the game here. Savings are for your emergency fund or money you're saving for something specific, like a new TV or vacation.
• Investing: Investing is about buying assets, such as stocks, that you believe will perform well in the long term. You might invest money you plan to use in your retirement, or for other long-term goals. Investments carry more risk than savings and there may be years when your assets fall in value. However, historically over time, assets held in a brokerage account have outperformed cash left in savings.

As Ryan King from Making Money Simple explained when we asked about his cash versus stocks strategy, "I keep an emergency fund and any sinking funds in cash, a sinking fund being a pot of money that I am saving for a specific goal. For example, for a house deposit or for a holiday. Any other money I invest."

How investing can build wealth

Consistently investing even a small amount of money regularly is a tried and tested way to build wealth over time. The S&P 500 -- often used as a benchmark for stock investments -- averaged an annual return of 9.9% between 1992 and 2021. Even if you adjust for inflation, it generated returns of 7.3% over 30 years.

It's easy to get lost in all this talk of percentages. Instead, let's look at how $5,000 might perform over a 30-year period if it earned a 9% versus a 5% annual return. These are very rough calculations, but they show the degree to which stocks will beat cash over time -- even using the current record-high savings rates. Inflation also fluctuates a lot, but we'll go with around 3% per year.

Here's how investing $5,000 and saving it might pan out over 30 years:

Don't let recession warnings stop you from investing

"OK, but what if we enter a recession?" I hear you cry. If we do hit economic difficulties and the stock market falls, wouldn't it be better to have your money sitting safely in a savings account rather than wobbling around in potentially turbulent stock markets?

There's no one-size-fits-all answer. If you're nearing retirement, you may well want to move a good chunk of your money to safer shores. But more widely, we don't know if a recession will arrive, nor what shape it will take. It is almost impossible to predict what will happen to the stock market in the near term. If you're a long-term investor, if you have cash to invest, it's often best to get on with it.

For example, 2022 was not a good year for the stock market. As we went into 2023, many analysts and investment professionals were pessimistic about the year ahead. Eight months later, it's a very different story. At the end of August, the S&P 500 was up about 17% year to date. The widely predicted recession has not yet materialized.

If you'd had money to invest at the start of this year, but decided to hold off in case the market dropped, you wouldn't have benefited from that jump. As King points out, "Just get started. Even if it's with a small amount. You're bound to make mistakes, overthink decisions, and change your strategy over time, but getting started is the key. Dip your toe in and let yourself get used to the volatile nature of the stock market."

It makes sense to have both cash and stocks

This doesn't mean you should dive in and invest all your money. Make the cash versus stocks decision based on your finances, not newspaper headlines. For example, if you carry a balance on your credit card, pay this down before you buy stocks. It's also important to have a solid emergency fund in cash that will cover your near-term needs. That way you wouldn't need to take on debt or sell your investments if you lost your job or faced a medical emergency.

However, once those financial bases are covered, investing your extra cash may make sense. As King explained, "The opportunity cost of holding cash is inflation and generally speaking, investing beats inflation over the long term whereas cash loses out due to inflation. So any money that I don't need in my emergency fund or sinking funds I get invested in the stock market."