In volatile markets, uncertainty frequently triggers hesitation. Recently, we’ve received numerous inquiries regarding secure places to store cash, especially from retirees or those nearing retirement. It’s natural to feel cautious or uncertain. When everything appears expensive or unstable, keeping money in cash may seem like the sole safe choice.
However, let’s dive deeper.
Is retaining your cash a smart long-term decision or merely a temporary pause in a larger strategy? Here’s how to approach it wisely and where to invest your money while you wait.
Reasons to Park Cash
There are typically two motivations for parking cash. You’re either apprehensive about market conditions and awaiting clarity, or you’re retired (or on the cusp) and want cash on hand for income reliability.
In both situations, you’re likely seeking investments with comparable traits. You require easy access to your funds, so liquidity is essential. You must also ensure that your capital remains safeguarded—safety is paramount. Securing stability is critical too, as you want your cash reserves to maintain their value. Ideally, your parked cash should yield some returns while you look for better opportunities.
High-Interest Savings Accounts (HISAs), money market funds, and ultra-short bond ETFs usually meet these requirements. Nevertheless, not all choices are equivalent, and some may have hidden disadvantages.
Misunderstandings About Cash Parking
Grasp this: HISAs are uniform products. Most provide the same basic benefits—safety, liquidity, and moderate returns. However, many investors become fixated on uncovering the “best” rate.
Here’s the reality: The variance between a 3.89% and a 4.16% yield on $100,000 is roughly $270 annually. After taxes, it’s about $135. This slight increase is unlikely to considerably affect your financial future.
Nonetheless, many investors spend significant time pursuing marginally improved yields. This time could be more effectively spent assessing your investment strategy or exploring companies on your watchlist.
HISA returns are:
– Not tax-efficient for non-registered accounts.
– Typically decline once central banks decrease interest rates.
– Generally ineffective against inflation over time.
Moreover, waiting on the sidelines for the “right moment” to invest results in an opportunity cost. Since January 2021, U.S. and Canadian markets have soared over 65%, despite ongoing negative headlines. If you waited for confirmation to re-enter the market, you missed significant gains.
A Strategic Approach to Cash: The Cash Wedge
For retirees, maintaining cash is more than just a responsive choice—it’s a strategic approach. This is where the cash wedge concept becomes relevant.
The idea is simple: During market declines, utilize your cash reserves to cover expenses instead of liquidating stocks at depressed prices. This strategy allows your portfolio time to rebound, preserving capital and dividend-yielding stocks.
How to build your cash wedge:
– Assess your portfolio’s annual income generation (e.g., $1M at 3% = $30,000).
– Establish your annual retirement budget (e.g., $50,000).
– Identify the deficit ($20,000 in this instance).
– Multiply that shortfall by three years = $60,000 cash wedge.
That $60,000 can remain in a HISA or money market ETF. The goal isn’t to achieve the highest yield; it’s about ensuring peace of mind and flexibility.
Risks of Excessive Cash Parking
Holding a cash wedge in retirement makes sense, but overdoing it can lead to unfavorable outcomes.
Key risks include:
– Decrease in purchasing power: Inflation diminishes your cash’s buying capacity. With a 4% HISA yield taxed at 40%, you net $2,400. However, in a 2.5% inflation environment, you’ll need $102,500 to preserve buying power, effectively losing $100.
– Declining interest rates: Current yields may not last. As rates drop, your returns are likely to decline.
– Absence of ideal market signals: You’ll never get a perfect signal to re-enter the market. Each year since 2021 has posed risks, yet markets have increased.
– Opportunity cost: Holding $100,000 in cash instead of investing could have resulted in a $50,000 loss in potential gains over the past few years.
If you’re parking cash out of uncertainty, consider: What would give me the confidence to reinvest?
Selecting an Optimal Cash Option
If a cash reserve fits your needs, streamline your selection criteria. Focus on the fundamentals.
Look for options that are:
– Liquid: You need quick access to funds without penalties.
– Safe and stable: Opt for trustworthy banks or major ETF providers.
– Tax-efficient: For non-registered accounts, consider products like HSAV that reinvest income.
– Low-fee: A reduced Management Expense Ratio (MER) improves net returns.
– Currency-aligned: Avoid USD options unless your expenses are in U.S. dollars—currency fluctuations can negate returns.