According to one study, the average person in their 20s is holding almost a third of their wealth in cash.
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One of the biggest mistakes I made in my 20s is a mistake that I'm still making now in my 30s: Too much of my cash is just sitting in a savings account, and I have no plan or strategy for what to do with that money.
As it turns out, I'm not alone — many young investors are making the same mistake. According to a study by Empower, the average person in their 20s is holding 28% of their wealth in cash.
While many experts have varying opinions on what percent of a person's portfolio should be cash (the common opinion is 10% to 20%), financial advisors say there are four reasons why keeping too much of your wealth in cash is a waste of money.
Whenever I find myself content that my financial portfolio is very cash-heavy, I reflect on the fact that keeping my money in a savings account means that it is losing value, and that's something I'll grow to regret.
Lauren Anastasio, director of financial advice and financial planner at Stash, says there's an opportunity cost to keeping cash.
"Even when inflation isn't making headlines, the value of your dollar continues to diminish with every passing year," said Anastasio. "$100 today simply will not go as far as it would have 10 years ago and is undoubtedly more valuable now than it will be 10 years from now."
She added that by investing it instead, you could reasonably expect an average annual rate of return of around 8%, and that holding too much cash means you're missing out on growth that would allow you to keep up with — or even outpace — inflation.
Even though it makes me feel financially successful when I refresh my savings account and see a satisfying amount, it's also telling that I don't have clarity around my future money goals.
Evon Mendrin, a financial planner, says that having too much cash can indicate a lack of financial goals or priorities.
"You don't know what to do with the cash, so it sits idle," said Mendrin. "If you get clear on what your financial priorities are, you can get a better sense of what to do next with extra cash."
So what should a person do instead? Mendrin recommends bucketing your money as a good next step.
"With your shortest-term bucket, include expenses you might need to pay for in the very near term, like an emergency fund," said Mendrin. "Once that bucket is filled, then think about your mid-term and longer-term financial goals. Invest the funds in alignment with those goals."
He said that for long-term goals like retirement, you can invest funds more aggressively, like stocks and real estate, that are expected to reliably outpace inflation over time. For mid-term goals, the funds can still be invested in things like bonds.
While having a lot of cash in your savings account can make you feel safe, Nate Hansen, a CPA, says you're missing out on opportunities by letting it sit there.
"Holding cash endlessly year after year instead of investing it is like never getting up the courage to ask your crush on a date in high school," said Hansen. "While the stock market has returned right around 10% over the long-run, there's also the compound interest aspect of invested funds over a long period of time."
Hansen says that if you still want to keep a portion of your portfolio in very low-risk securities, then consider treasury inflation-protected securities, or TIPS.
"These are US treasury bonds that are adjusted for inflation based on the consumer price index," said Hansen. "TIPS protect against inflation by the actual face value of the bond being adjusted for inflation, instead of adjusting the interest rate."
Tony Matheson, a financial planner, recommends using excess cash to max out retirement accounts and to help offset your taxes.
"If you are not already taking advantage of the full limits of your 401(k) or Roth IRA, you are paying more in taxes than necessary," said Matheson. "Next, you can prepay taxes that will be due in future years through a Roth conversion. If you have money in a rollover IRA, consider converting those dollars into a Roth IRA."
"You will have to pay taxes now, but once that money is in a Roth IRA, it will never be taxed again — both the growth and withdrawals," he added.
This article was originally published in April 2022.
