Is holding too much cash a mistake? Here's why that may lead to regrets, experts say

Experts are raising concerns about an increasing obsession with cash investments, particularly among younger investors, and the potential risks of missing out on higher market returns. The concern is that a significant amount of money, estimated at $6 trillion, is currently parked in money market funds, with a large portion allocated by younger investors who have a longer time horizon to absorb risk.

According to Callie Cox, chief market strategist at Ritholtz Wealth Management, over 55% of wealthy younger investors have increased their cash allocations in the past two years, compared to 46% of older investors. This trend, Cox argues, is a result of the allure of the 5% savings rate offered by cash investments. However, she warns that under-investing is a risk, particularly for younger investors who may miss out on potential gains from stocks.

While a 5% return on cash may seem attractive, it may fall short of the potential gains that can be earned from stocks. A more aggressive portfolio allocation to stocks may yield an average annual rate of return of 7%. For instance, the S&P 500 index is predicted to climb to 5,800 by the end of this year, bringing its total return to more than 20% for the year. This would be a significant gain for those who have invested in stocks, while those who have relied on cash would miss out on these returns.

It’s important to note that all investors should have some cash set aside for emergencies, with financial advisors generally recommending having at least three to six months’ worth of expenses in cash. However, for goals beyond five years, Cox suggests considering putting that money into stocks or other riskier assets.

The risk of missing out on market upside may be the bigger opportunity cost for those who choose to sit on the sidelines in cash, according to experts. While there’s always the possibility of market downturns, the risk of missing another leg of the rally could be the biggest risk for investors now.

The environment for cash savings may change in the future, as the Federal Reserve has signaled plans to eventually start cutting interest rates as inflation subsides. This could make a 5% return on cash a thing of the past, and savers may need to consider locking in five-year certificates of deposit at today’s rates. However, they should be aware that they will need to pay a penalty if they want to access that money sooner than five years.

In conclusion, while cash investments may seem safe, experts warn that an over-reliance on cash could lead to missing out on potentially higher returns from the stock market. Younger investors, in particular, are urged to consider a more aggressive portfolio allocation to stocks for long-term goals.

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