Is Cash Hoarding a good idea?

Inflation Data

To begin, let's explore the reasons behind people's investment decisions and asset allocation planning. This is primarily influenced by inflation, as the value of our currency diminishes each year. As of October 2023, headline inflation stands at 4.7%, which is lower than the peak of 6.6% observed in January 2023. In theory, if your cash is growing at a rate lower than the current inflation rate, you are essentially experiencing a monetary loss.

When should we keep cash then?

Cash is undeniably essential, serving as one of the most liquid assets for emergencies and day-to-day expenses. The commonly followed guideline is to maintain 3-6 months' worth of living expenses. However, it's crucial to consider personal circumstances, such as job stability, family situations, and exposure to various risks.

Probability of Cash Outperforming Stocks

The probability of cash outperforming the renowned S&P 500 index diminishes over time, as illustrated above. The likelihood of cash outperforming stocks within a 1-year timeframe is 31%, which may seem reasonable and worth considering. However, this probability decreases to 1% for a 20-year timeframe and reaches 0% for a 25-year timeframe. Historical data from the past century indicates that holding onto cash is unlikely to yield returns comparable to investing, especially when considering the impact of inflation.

Average Underperformance of Cash VS Stocks (1928-2022)

Examining another drawback of maintaining a long-term cash position with a different metric, the opportunity cost is minimal in the first year, at 8% over 1-year periods. However, over 25-year periods, it exponentially increases to -1,281%. With that in mind...

Probability of Positive Returns

We must examine the worst possible outcome of investing using historical data, even though ultimately there are no guarantees in investing. Based on data from the past century, if an investor stays committed for just over 15 years in the S&P 500, there is zero chance of a negative return on the investment.

Wrapping up

Objectively, every asset class, including cash, serves a unique purpose. In my opinion, calculating the necessary emergency cash amount mathematically is advisable. Additionally, consider your psychological comfort levels—ensure you are comfortable but not overly so, as excessive comfort may result in a long-term loss of net worth.