As a financial advisor, I’m often asked, “Is now a good time to invest?”. This question comes during up and down markets alike—usually from someone with a pile of cash. People seem to think I have the secret. I have no secret. Ok, I do. The best time to invest was yesterday. The next best time is today. Timing the market is a game you will ultimately lose while creating bad habits along the way. Does that mean you should never accumulate sizable cash balances in your bank accounts that yield little to no returns? Definitely not. Here are 3 reasons to keep cash around:
1. Your personal emergency fund
Cash is a buffer for the unknowns of life. To determine how much you need in your emergency fund, first figure out your monthly personal living expenses. Then multiply that number by 3 to 6. If you have a two-income household, 3 months’ worth of cash is probably adequate. If you have a single-income household or you are just getting started in your career, you may want to shoot for 6 times your monthly spending. As your after-tax investments (i.e. money in brokerage accounts) grow, you can consider holding less cash in your emergency fund because you have a second source of assets available in a pinch. Personal preference is also a factor. If having more cash is going to help you stay invested in your retirement accounts when the markets get rough, then do what suits your personality. Know thyself before implementing your plan.
2. Your business emergency fund
Businesses face countless unexpected issues that can pop up at any moment (*cough* 2020). Like your personal life, your business needs a margin of safety for the perils—big or small—that are sure to come. The formula for your business emergency fund is slightly different from the formula I recommend for your personal emergency fund. Take your monthly spending (overhead) in the business and multiply that by 1.5 to 3. On the heels of COVID, a lot of dentists are opting for the higher end of that scale. I’m supportive of that decision, but don’t see a reason to accumulate any more than 3 months’ worth of spending in business cash. That is unless you’re talking about the third reason to hold onto cash:
3. A large, one-time expense
Planning ahead for big purchases is critical for financial success. This could either be in the business or on the personal side. It might be a cone beam for the office or a swimming pool at home. You might not even be sure about the details or timing—like upgrading your home or expanding the office. Maybe you had an unusually big year and you want to make sure you have enough for the tax bill to come. Stockpiling cash for these reasons makes sense.
All too often I hear that someone is sitting on the investing sidelines because the “market is too expensive” or “there is going to be a crash soon”. I get it. Investing is scary. If you invest for any significant amount of time, you will inevitably see the value of your assets drop. But a few things to remember:
First, having enough cash on hand provides a buffer that allows your long-term investments to fluctuate—as any investment will—without causing you to freak out. A level head and a safety net make room for the power of time to do its work on your returns. Zoom out far enough across several years and you’ll see that markets have always gone up. They just don’t do it in a straight line, which is why money invested for the long term shouldn’t be disturbed by the whims or worries of the short term.
Secondly, if you are saving consistently then you can stop guessing when the best time is to invest. In other words, the habit of saving a certain percentage of your income on a recurring schedule is what really matters over time—whereas the right day to invest is anyone’s guess. When the market does drop—and it will—you will benefit from “buying the dip”.
Lastly, sitting on cash is more of a danger to your wealth than putting your money in the stock market. True risk is a real loss of your money’s purchasing power—not just a temporary drop in value on paper. Your net worth is sure to erode over time if your money is not invested in assets that grow. Is there a reason to hold cash? Yes. But waiting for the “right time” to invest isn’t one of them. Have a buffer. Plan ahead. Then invest the rest.