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Back in February, we learned that most Americans are behind on emergency savings, with more than half of U.S. adults lacking the funds needed to cover six months’ worth of living expenses. But what happens once you establish that emergency fund? Do you need more cash than that?
There’s nothing wrong with having cash at your disposal that isn’t earmarked for emergencies only. In fact, it’s actually smart to keep some cash in your brokerage account so that if an investment opportunity comes your way, you won’t have to sell off another position to pursue that prospect.
But there is such a thing as having too much cash, and according to new data from NerdWallet, Americans might be falling victim to that very mistake. A recent survey reveals that U.S. adults currently hold $32,286 in cash on average. And that’s a pretty sizable chunk of money to not have invested.
The appeal of cash
Why do so many Americans cling tightly to cash? For many, it’s the peace-of-mind factor. Unlike stocks and bonds, which carry investment risk, when you keep your money in cash, you don’t risk losing any of your principal. And that alone prompts many U.S. adults to forgo returns in favor of security.
In fact, it’s estimated that 39% of Americans aren’t investing at present. Of them, 32% claim they keep their money in cash to have easier access to it. Meanwhile, 28% hang onto cash because they don’t know how to invest.
The problem with too much cash, however, is that you lose the opportunity to make money on that money. Right now, you’ll get 1% interest from a savings account on a good day. You’ll do better with a certificate of deposit, scoring up to 3% on a five-year term, but that’s still nowhere close to what a stock-heavy portfolio might give you. And while that may not make much of a difference over the course of, say, a one-year period, it could make a huge difference in the long run.
Imagine you’re sitting on $32,286 in cash. Let’s be optimistic and assume interest rates go up for savings accounts over time so that over the next 30 years, you score an average annual 2% return. After 30 years, you’ll have grown your money to $58,481.
But watch what happens when we invest that $32,286 in stocks instead. The stock market’s historical average is roughly 9%, but let’s be pessimistic and assume we don’t do quite as well. If we work with an average annual 7% return on investment, after 30 years, you’ll have $245,769. That’s a $187,288 gap we’re looking at. So if you’ve been keeping your money in cash, ask yourself this: Does an extra $187,288 sound good to you? If so, then consider putting your money to work by investing it rather than playing it safe.
Getting started with investing
A big reason so many people prefer to keep their money in cash is that they’re just not sure how to invest it. And while there are beginner guides out there that will show you how to get started with stocks, there’s still a lot of legwork involved in choosing individual companies to invest in.
That’s why index funds are a good bet if you’re truly clueless about investing. Index funds simply track existing indexes so that when the market goes up, you get a piece of it. Take the Vanguard S&P 500 ETF (NYSEMKT:VOO), for instance. This fund invests in the 500 companies that comprise the famous S&P 500 index, so when you buy shares of that fund, you’re getting instant diversification in your portfolio.
Of course, there’s a host of choices you might play around with, but if you’re fairly young and have at least a 10-year investment window, you’re more likely than not to make money in the stock market. And while you are taking a risk that doesn’t come with leaving your money in cash, the rewards you stand to reap make it totally worthwhile.