When it comes to financial security, it’s comforting to know that you have enough cash reserves to tap into when you need them.
But there’s also a downside to storing cash: it can lower your portfolio’s returns over the long term.
Of course, having a rainy day fund can help you survive financial problems like an unexpected car repair or job loss. But cash really shouldn’t play a big role in investment accounts meant to fund long-term goals like retirement.
âCash becomes a drag on returns very quickly,â said Kristin McKenna, Managing Director of Darrow Wealth Management.
Compare short-term needs with long-term goals to find an optimal cash flow position. Personal finance professionals recommend a âbucketâ approach that spreads cash over three different time periods.
A zero cash allocation is not crazy. Once you’ve funded compartment one and two and can survive Financial Armageddon, you probably have enough protection to invest aggressively with compartment three.
- Emergency fund. You need cash savings for emergencies like an unexpected healthcare bill.
Think of your emergency compartment “as your personal safety net when life throws a curveball at you,” said Judith Ward, senior financial planner at T. Rowe Price.