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Don't hold too much cash: That's 'dead money,' says personal finance expert — here's a good balance

"Cash is there to serve mainly as your emergency reserves, to cover unexpected bills as well as job loss."

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Cash is king. Money talks. The almighty dollar. People love the green stuff because, no matter what markets do, cash is still cash. It won't decline in value, as can be the case with stocks, bonds, gold, fine art, crypto, or any other asset.

"If you have $100,000 in a savings account, you know that 10 years from now, that will still be $100,000. You didn't lose any money," says Howard Hook, a certified financial planner and principal at EKS Associates in Princeton, New Jersey. "But we also know that $100,000 doesn't buy what it did 10 years ago."

Oh, right. Inflation. When the prices for goods and services are rapidly rising, as they have been in recent months, holding cash in your portfolio becomes less attractive.  

The prospect of prolonged inflation "argues against having too much in cash," Christine Benz, director of personal finance and retirement planning at Morningstar, recently told The New York Times. "That's too much dead money."

That isn't to say it's time to starting pulling spare change out of your drawers to invest in the stock market. But experts say you'd be wise to be wary of having too much of your money in cash. Read on to find out how they recommend you responsibly incorporate it into your financial picture.

You need cash for emergencies, short-term goals

If you're a young investor looking to accumulate wealth, "cash is there to serve mainly as your emergency reserves, to cover unexpected bills as well as job loss," Benz tells Grow. "You generally want three to six months' worth of living expenses in cash."

That can seem like a big number, Benz concedes — one that you can mentally shrink a little by considering how you'd live if, say, you lost your job and needed to live off the cash. "If you have a job loss, you'd make some changes. You'd probably cut your gym membership and get rid of your subscriptions, for instance," she suggests.

"Think about the bare minimum you'd need to get by."

You'll need to hold enough cash to cover your day-to-day living expenses, says Hook. "Besides an emergency fund, you always need some access to cash," he says. "Ideally, you have a pool of funds to draw from so that you're not taking money out of your stock investments when markets are down."

Any money that you plan to deploy for a short-term goal — one happening in the next one or two years — is best kept in cash, Benz notes. Because there is no chance of a decline in value, "cash is the best option, even if inflation is a risk factor," she says.

Cash doesn't belong among your long-term investments

Once you have your short-term bases covered, experts recommend investing in assets that have a chance to offer you compounding growth. But young people — who theoretically have the most to gain from years of compounding — aren't taking full advantage.

Investors in their 20s hold more than 28% of their assets in cash, according to a 2021 survey from Personal Capital.

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At least some of that number is likely due to investors failing to check in on their portfolios. Have you heard of sweep accounts? Say you open an account, such as an IRA, with a brokerage. If you deposit $5,000, that money is "swept" into a cash account until you choose another way to invest it.

The same thing happens if you set up recurring deposits. Did your investments earn dividends? Those may be swept in, too.

If you set up your IRA but haven't chosen an investment, starting with a diversified, all-in-one fund, such as a target-date fund, may get the investing ball rolling, Benz says. "If you open account and aren't really conversant in how they work, these kinds of funds might be a good option to address that paralysis," she says.

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If you're already investing, check in to make sure you're not holding more cash than you want. Or better yet, says Benz, set up your contributions and dividends to invest in your portfolio regularly and automatically. This way, she says, you avoid the temptation to try to deploy your cash when you think the market is likely to go up.

"Cash might serve a role for people who are looking to take advantage of periods of market weakness," she says. "But that starts to bleed into market timing. And you don't want to sit out periods of market strength."

Investing wisely is 'the only way' to deal with inflation

So if inflation is going to eat into the value of your cash, what would be wise to hold instead?

It all depends on when you need the money, Benz says. For people who are building a portfolio for an intermediate-term goal, Benz would usually recommend a mix of stocks, short-term bonds (which tend to be less sensitive to rising interest rates than longer-term bonds), and cash.

In high-inflation environments, Benz suggests supplementing your bond holdings with Treasury Inflation-Protected Securities, government bonds that pay higher interest rates as inflation rises. "I wouldn't have 100% in TIPS or use them in place of other bonds types," she says. "But I'd use them as a portion of the portfolio."

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For investors with longer-term goals, "the only way to really deal with a loss of purchasing power is to buy investments with the ability to go up more than inflation most of the time, but can go down," says Hook. "By that I mean investing in stock mutual funds and index funds, not individual stocks."

Historically, it's been true that the broad stock market has outrun the pace of inflation, even if over short periods, your portfolio may falter. "If inflation is up 7% in a year, there is no guarantee stocks will match that," says Benz. "Stocks can go down."

But younger folks needn't fret too much about inflation's long-term effects on their nest eggs, Benz adds. "Your salary helps make you whole with respect to inflation if you have cost of living adjustments," she notes. "And if you're holding stocks, you have some protection long-term against inflation."