How Much Are You Losing To Idle Cash?
Uninvested cash may feel more readily available compared to when it's invested, but there can be better ways to manage your funds. Find out how.
So far, we’ve told you about the consequences of having uninvested cash in your investment portfolio. But cash is king, and so even the most savvy investors still keep money in places like checkings and savings accounts in order to have easy access to those funds, which then can be used for day-to-day expenses.
Here at Betterment, we want you to do better.
What Is “Idle Cash”?
Idle cash is money that is not invested in anything and is therefore not earning investment income. It’s money that is not actually participating in the economy-- not being spent on anything and not increasing in value. Therefore, it can’t earn you anything.
Ultimately, keeping idle cash on hand is simply not as beneficial as you may think.
In fact, these funds are frequently considered wasted, as they typically cannot keep up with the effects of inflation. In the U.S., the inflation rate that the Federal Reserve targets is 2% annually-- given that your idle cash likely does not increase in value, its purchasing power actually decreases as time passes.
That’s right—uninvested funds gradually lose value, since they are unable to keep up with the rate of inflation, which means that as time goes on, the $100 under your mattress can eventually only buy $98 worth of things, then $96, then $94, and so on.
And that’s just inflation—the opportunity cost of keeping cash that you otherwise could invest in the market is even worse.
Why do people keep uninvested cash?
Despite the fact that keeping idle cash can be detrimental to a successful, long term savings plan, there are still plenty of reasons for people to keep cash on hand.
Accessibility and liquidity are huge factors—investors want to be able to pay their bills from their checking accounts with the click of a button, for example—as is safety and security, and the fact that savings accounts from member banks are FDIC-insured.
The current reality is that among the checking and saving accounts out there, the return on deposited funds is very low. In fact, the FDIC announced that as of February, the average yield on a savings account is 0.09% APY—in a 2% inflation environment, this is still a purchasing power losing investment. The yield on checking accounts is even worse—most of these products have very low interest rates.
How much uninvested cash can I get away with keeping?
While a small portion of uninvested cash may seem insignificant, it can be disadvantageous for at least two reasons:
- Preventing it from keeping up with inflation rates means your cash loses value over time, and
- You fail to benefit from money that can compound over time and garner even higher returns.
Typically you shouldn't reinvest cash if it costs you more to actually invest it than what you would earn, due to, for example, broker commissions. However, at Betterment, the absence of trading commissions, as well as our ability to support fractional shares, help ensure that every last cent of your cash is being put to work for you.
If we assume an average trading cost of $7 per trade (typical of discount brokerages) and you don’t want to reduce your returns by more than 1%, then you should have, at most, $700 of cash.
Even though we recommend having no cash at all because any amount may reduce your returns, for practical reasons we believe portfolios have too much cash when they exceed $700 in cash.
How should I manage the rest of my cash instead?
There are many schools of thought as to how cash can be managed, but the most common objectives are the following:
- Yield (without meaningful risk) and liquidity-- simultaneously making sure that your cash does not waste away due to the effects of inflation while mitigating potential high risk.
- That you are able to access your cash within a reasonable amount of time.
At Betterment, we spend a lot of time thinking about how to help you make the most of all your money. Idle cash results from cash dividends which are not reinvested. When you use Betterment, your dividends are automatically reinvested, resulting in zero idle cash and zero cash drag from your accounts.
In addition, we provide you with a holistic picture of all your investment accounts from a cash management perspective, from idle funds in external accounts to the cash inside the funds you purchase. We highlight each portfolio’s total idle cash, along with a simple projection of how much potential returns could be lost by holding that cash amount long-term.