Is cash really an investment, or does it just drag down your returns? While cash often earns very little and can seem like a drag on your finances, it does have its place, especially during market downturns.
Recently, a debate arose between Charles Schwab’s new robo-advisor service, which recommends keeping 8-30% of investments in cash depending on market conditions, and its competitors, Wealthfront and Betterment. These competitors argue that such a high cash allocation could potentially hurt clients by missing out on higher returns from other investments. However, Schwab benefits from this arrangement by reinvesting the cash at higher rates, effectively operating like a bank with low-cost funding. This strategy isn’t well known outside the finance industry, but it’s a common practice.
While Wealthfront and Betterment keep their clients’ portfolios fully invested, they do charge fees ranging from 0.15% to 0.35% and have additional costs from the ETFs they use to build these portfolios. On the other hand, Schwab charges no fees for its robo-advisory services, making its high cash recommendation stand out.
But let’s set aside which business model might be better and focus on the role of cash as an investment. Historically, having cash has been crucial during market crashes. Anyone who suffered losses in the early 2000s or during the 2008 financial crisis might agree that having cash on hand would have been beneficial.
For example, consider someone with $100,000 to invest. They might choose to invest $10,000 in a robo-advisor, put $80,000 in an S&P 500 index fund, and keep $10,000 in cash. If the robo-advisor only invests 70% of that $10,000, the investor ends up with an overall cash allocation higher than desired. This scenario shows why it’s crucial to understand how each part of your investment contributes to your overall financial strategy.
In reality, the proportion of an investor’s total net worth managed by a robo-advisor might just be a fraction of their entire investment portfolio, which can skew perceptions of cash allocation. Getting clear data from providers like Schwab, Wealthfront, and Betterment on how much of their clients’ investable net worth they actually manage would provide better clarity.
In conclusion, whether cash can be considered an investment really depends on your perspective and situation. In times of volatility, cash can be a safe haven or a ready reserve to take advantage of market dips. However, over the long term, holding too much cash can mean missing out on potential gains from other investments. Thus, while cash might not be an aggressive growth strategy, it’s a critical component of a well-rounded financial plan, serving both as a buffer against market volatility and a tool for capital preservation.
