Are You Holding Too Much Cash?

Cash has an obvious appeal. It is stable, accessible, and easy to understand. When markets are volatile, there is also comfort in knowing that the balance in a savings account is not moving up and down with the headlines.

That makes cash an important part of a financial plan. The question is whether the amount you are holding still makes sense.

For some people, a large cash balance is completely appropriate. There may be a home purchase coming up, a renovation, a tax bill, a major trip, or an upcoming retirement. Others simply want enough set aside to deal with an unexpected expense without having to sell investments at an inconvenient time.

Problems tend to arise when cash accumulates without a clear purpose, or when money that was originally set aside temporarily stays there for years.

Start with what the cash is for

There is no single amount of cash that is right for everyone.

The Financial Consumer Agency of Canada suggests building an emergency fund of roughly three to six months of regular expenses, but that is only a starting point. Someone with irregular income, a business, significant property expenses, or upcoming retirement withdrawals may reasonably want more.

The more useful question is what the money needs to accomplish.

Some cash may be there for emergencies. Some may be earmarked for spending over the next year or two. Retirees may also want a portion available for regular withdrawals so they are not forced to sell investments during a market decline.

When there is a clear reason for holding the money, cash is doing exactly what it is supposed to do.

The trade-off is purchasing power

The downside of cash tends to show up over longer periods.

The Bank of Canada targets inflation at 2 percent over the medium term, within a range of 1 to 3 percent. Even at that relatively modest level, the cost of goods and services rises considerably over time.

At 2 percent annual inflation, something that costs $100,000 today would cost roughly $122,000 in ten years.

That is the part that can be easy to miss. Your bank balance may look stable, but what matters is what that balance will actually buy in the future.

Interest can help offset some of that effect, but the return on cash may not always keep pace with inflation. In a non-registered account, tax on interest income can reduce the return further.

For money you expect to spend soon, that may be a reasonable trade-off for stability. For money you do not expect to use for another 10 or 20 years, it deserves more thought.

Time horizon changes the role of cash

Money needed next year has a different job than money intended for retirement decades from now.

If you know you will need funds soon, avoiding a large short-term decline may matter far more than earning a higher return. There may simply not be enough time for markets to recover before the money is needed.

With longer-term money, the risks change. Inflation and missed growth become more important because those dollars need to maintain their purchasing power over many years.

This is why a good plan usually separates short-term needs from long-term assets rather than treating every dollar the same way.

Cash can be very safe over a short period and still be a poor fit for a long-term goal.

Retirement makes the balance more important

Cash plays an especially useful role in retirement.

Once employment income stops, expenses may be funded from a combination of pensions, CPP, OAS, RRIF withdrawals, TFSAs, non-registered accounts, and other assets. Having enough liquidity available can make that income easier to manage and reduce the need to sell investments simply because an expense comes due.

At the same time, retirement can last 20 or 30 years or longer. A portfolio that becomes too heavily weighted toward cash may struggle to keep up with rising costs over that period.

The appropriate balance depends on how much income is needed, where that income is coming from, and how much flexibility exists elsewhere in the plan.

A large cash balance is not automatically a problem

There are plenty of situations where holding substantial cash is intentional.

Someone may have just sold a property or business. An inheritance may have been received. A client may be waiting to buy a home, preparing for retirement, or setting aside money for taxes. In those circumstances, keeping the funds liquid while the next decision is made can be entirely reasonable.

What is worth reviewing is cash that no longer has a clear purpose.

Maybe the expense it was meant for never happened. Maybe the money accumulated during a volatile market and was never reinvested. Maybe savings simply built up over several years.

None of those situations automatically require a change. They are simply good reasons to revisit the plan.

How much is too much?

Rather than choosing an arbitrary percentage, it can be more useful to work backward from what you expect to need.

Consider your emergency reserve, major expenses over the next few years, retirement withdrawals, taxes, travel, family support, renovations, and any other known commitments.

Once those needs are accounted for, look at what remains.

If a significant amount of cash is left over without a short-term purpose, ask whether it still belongs there or whether some of it is really long-term money.

A few questions can help:

1. Why am I holding this amount?

2. When do I expect to use it?

3. Has the original reason for keeping it in cash changed?

4. Am I holding it because I need liquidity, or because I am uncomfortable investing it?

5. Is the return keeping pace with inflation after tax?

6. Could some of this money have a longer time horizon than I originally expected?

There is nothing wrong with deciding that the cash should stay where it is. What matters is that the decision is intentional.

The Bottom Line

Cash provides stability, flexibility, and peace of mind. It can protect near-term spending needs and make it easier to deal with unexpected expenses without disrupting the rest of a portfolio.

But cash also has a cost when it is held for too long. Inflation can gradually reduce purchasing power, and money intended for long-term goals may miss years of potential investment growth.

The right amount will be different for every household. It depends on income, spending, retirement plans, upcoming expenses, risk tolerance, and the role the rest of the portfolio is meant to play.

At DO Wealth, we look at cash in the context of the full plan. If your cash balance has grown significantly, or money that was originally set aside for the short term is still sitting there years later, it may be worth reviewing whether it still has the same job.

This article is for informational purposes only and does not constitute financial, investment, tax, or legal advice. The appropriate level of cash depends on individual circumstances, objectives, time horizon, and risk tolerance. Speak with your DO Wealth advisor before making changes to your financial plan.