As market volatility increases, you may be tempted to abandon your investment strategy and go to cash. Indeed, staying on the sidelines often feels safer than investing in the stock market. Yet going to cash can yield worse results than staying the course. If your instinct is to sell when markets are bumpy, consider the potential risks of holding too much cash.
Risk #1: Inflation Erodes the Value of Cash Over Time
Like volatility, inflation is an ever-present risk. But unlike volatility, inflation can significantly affect your long-term financial goals if you ignore it.
The Federal Reserve generally targets an inflation rate of 2% over the long run. At times, the inflation level can exceed that target—sometimes meaningfully. For example, inflation rose 7.5% year over year in January 2022, making it the fastest annualized acceleration in prices since February 1982.
Whether inflation is stable or rising, it can make your dollars less valuable over time. That’s why it’s so important to invest in stocks and other growth-oriented investments.
The returns of these investments tend to outpace inflation over time, so you can maintain your purchasing power in retirement. On the other hand, holding too much cash can lead to other risks, like outliving your savings.
Risk #2: Market Timing Is Challenging (If Not Impossible)
Market timing requires two decisions: when to get out of the market, and when to get back in. Unfortunately, few investors can consistently get the timing of these two decisions right.
In fact, research consistently shows that the average investor has a strong tendency to sell at the wrong time, especially when there’s sudden market volatility. According to market researcher Dalbar, the average investor not only consistently underperforms the market, but they also underperform their investments due to poorly timed trades.
In other words, going to cash may be comforting when the market is declining. However, holding too much cash means you’ll miss the subsequent recovery if you don’t get back in the market in time. A better strategy is to stay the course and use market dips as an opportunity to buy stocks at discounted prices.
Risk #3: You Probably Need More Money Than You Think for Retirement
If you’re holding too much cash, that probably means you’re underinvested, which can weaken your retirement plans. The truth is for most retirement savers, investing is a must. Otherwise, you run the risk of outliving your assets in retirement.
Here are three reasons why you’ll likely need more money than you expect for retirement:
Rising Healthcare Costs
Healthcare is one of the most significant costs you’re likely to encounter in retirement. Consider the following statistics on the cost of healthcare for those 65 and older:
- One report estimates the lifetime healthcare cost for retirees at over $400,000
- The Urban Institute estimates that 70% of retirees will require long-term care
- Insurance company Genworth puts the yearly cost of nursing care at over $100,000
And these costs are rising. That means you’ll likely need to invest in equities to grow your nest egg. In other words, holding too much cash may limit your financial resources in the future.
Longer Life Expectancy
Stanford research shows that every generation can expect to live roughly three years longer than their grandparents, on average. That’s good news, as long as your retirement savings can cover these additional years.
Investing wisely can help ensure you have adequate funds to enjoy your golden years—and cover the costs that come with them.
You Can’t Rely on Social Security & Medicare Alone
In most cases, you won’t be able to rely on Social Security and Medicare to fund your retirement years—at least not fully. As of today, the average retiree spends 30% of their Social Security funds on healthcare alone. And Medicare doesn’t cover many of the healthcare costs retirees often face.
That means you’ll likely need supplemental sources of income in retirement—for example, investment accounts that continue to generate growth and income throughout your golden years.
Tips for Staying the Course
By now, it’s clear that holding too much cash typically isn’t a viable long-term strategy for meeting your financial goals. So what can investors do to better manage their wealth? Here are three tips for staying the course when volatility spikes:
Tip #1: Ignore Financial Headlines
Beware of “clickbait,” the kind of headline designed to tug your emotions and generate more views for the news agency. Sure, many national and world events understandably stir our emotions, but you can’t always react to these events by altering your investment strategy. Instead, ignore the headlines and focusing on controlling what you can.
Tip #2: Stick to Your Investment Plan
In all likelihood, your current investment plan reflects careful strategy and a thoughtful process. Don’t let current doubts or financial fears make you second-guess yourself. Instead, stick to your plan, and focus on long-term gains rather than short-term fluctuations.
Tip #3: Delegate Your Investment Decisions to a Trusted Financial Advisor
The good news is you don’t have to go it alone. A trusted advisor can help you develop a long-term financial plan and investment strategy that considers your risk tolerance and long-term goals. They can also help hold you accountable when abandoning your investment strategy feels tempting. If we can help you develop a plan to meet your long-term goals, please schedule a complimentary consultation to see if we’re a good fit. We’d love to hear from you.
About the Author
Gretchen Behnke, MBA, CFP®, RLP®
Gretchen Behnke is a fiduciary financial planner and owner of Pearl Financial Planning. We are a fee-only firm providing financial planning, life planning, and investment management services to professional women and couples across the country. Our mission is to help women build wealth.