Holding “too much” cash can be a good thing

“Inflation is destroying your savings – you need to have your money invested”, goes the typical personal finance advice. After building your emergency fund, conventional wisdom says that the rest of your money should be working for you at all times.

This makes sense as a general principle, but I don’t believe it’s true for everyone in all cases.

For example, say you’re holding £100,000 in cash (on top of your emergency fund) in a bank account paying 0.5% interest. Let’s assume inflation is running at 2.5%, so every year you’re losing 2% in purchasing power – or £2,000 in the first year. Ouch!

But then an investment opportunity comes along that allows you to buy at a 20% discount – on the condition that you can put in the money immediately.

That 20% saving more than compensates for the spending power you lost to inflation, plus the return you would have made from having your money in a “normal” everyday investment that wouldn’t be available at a discount.

In other words, holding cash opens up opportunities that wouldn’t be available if you just whisked off all your spare cash into a stock market investment account at the end of every month.

Cash isn’t always the answer

This only works when you’re sitting on cash for a relatively short amount of time, or keeping a static amount strategically for opportunities – not just letting it pile up aimlessly.

For example, maybe you’ve been convinced for the last six years that a property crash is about to happen so you’re sitting on cash ready to pounce. By the time it eventually happens, there’s a good chance you’ll have missed out on so much growth and income (and lost so much spending power to inflation) you’ll still come out behind even when you do eventually get to snap up that bargain.

It also only works if you’re holding cash for the purpose of taking advantage of opportunities, not because you’re too scared to invest in case you lose money. If that’s the case, you’ll also be too scared to take advantage of the opportunities that cash opens up.

The poker analogy is “tight but aggressive”: you fold the majority of hands, but bet big and aggressively when the right opportunity comes along.

So should everyone be sitting on cash, ready to pounce? No: for most people, the standard advice of drip-feeding into investments will be the right thing to do.

But if you’re a confident investor and you understand the rules, you can potentially do well by breaking them.