Amid recent volatility in the stock market, many investors may feel compelled to liquidate their assets in favor of cash. Although cash is often perceived as a safer option, financial experts caution that it may present its own set of risks for those planning for the long term.
Experts note that cash, which includes funds held in high-yield savings accounts or money market accounts, typically exhibits significantly less volatility compared to stocks in the short term.
However, cash also tends to offer lower returns compared to stocks over extended periods. Keeping an excessive amount of cash rather than investing it may hinder an investor’s ability to meet their financial goals, as highlighted in a recent report by Vanguard, which examined the comparative returns of stocks versus cash.
As U.S. stock benchmarks reacted sharply to tariff announcements from the Trump administration and retaliatory actions from key trading partners such as China, many investors chose to retreat to perceived safe havens.
Immediately following the White House’s announcement of targeted tariffs earlier this month, the S&P 500 experienced its most significant drop in two days since the early days of the Covid-19 pandemic, resulting in a decline of approximately 11%.
Additionally, April 7 marked the highest trading volume in 401(k) plans since March 12, 2020, according to Alight Solutions. Notably, around 94% of these transactions were directed toward conservative asset options, such as money market and bond funds.
Evaluating the benefits and drawbacks of cash
Cash does offer several advantages.
For instance, it provides liquidity for emergencies and significant purchases, even amid market fluctuations, according to Carolyn McClanahan, a certified financial planner and founder of Life Planning Partners in Jacksonville, Florida.
“Everyone should maintain a balance of cash and equity investments,” McClanahan stated in an email, emphasizing its importance.
Nonetheless, cash has typically yielded negative “real” returns when adjusted for inflation, as noted by Morningstar.
Experts warn that holding a portfolio entirely in cash can lead to a gradual erosion of wealth when inflation is considered. If interest rates on cash fail to keep pace with inflation, investors risk losing purchasing power.
In contrast, stocks hold the potential for substantial growth, particularly over the long term, albeit with inherent risks, McClanahan cautioned.
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The fluctuations in the market can be unsettling, and if immediate cash needs arise during a downturn, investors might incur losses if they cannot withstand such challenges, according to McClanahan.
“A diversified portfolio should include both safe and risky assets, tailored to a client’s financial and psychological comfort with risk,” she advised.
Strategies for cash and stock allocation
Any cash earmarked for short-term expenditures within the next five years, such as a home down payment, vehicle purchase, or educational fees, should also be allocated similarly, she suggested.
The remaining capital should be invested in stocks and bonds based on the investor’s time horizon and their individual capacity to handle risk, McClanahan added. For example, an individual with a decade until retirement should generally allocate a smaller percentage of their portfolio to stocks compared to someone with 30 years left until retirement.
People approaching retirement should ensure they have sufficient cash, short-term bonds, and certificates of deposit to support five years of income requirements, as well as any significant upcoming purchases, she advised.
The rest of their investments should be diversified across stocks and fixed-income securities.
Even retirees should consider maintaining a portion of their portfolio in stocks, as their investments may need to sustain them for several decades, necessitating some level of growth to prevent depleting their funds prematurely, experts argue.
All investors are encouraged to adopt a clear investment strategy that details the allocation between equities, fixed income, and cash, and to adhere to this plan throughout varying market conditions, McClanahan reiterated.
