MoneyLife

Saving cash for a rainy day

By MoneyLion

The past year has been a reminder to investors to keep a cushion of cash, if they can. Having enough cash saved up can not only help to pay bills and expenses on a rainy day, but it can also be valuable for an overall portfolio. This is because having the discipline to control personal spending is one of the best ways to help improve your financial wellness. The more money that can be socked away rather than spent, the more one’s portfolio, financial picture and net worth may be able to grow over long periods of time.

During the pandemic, Americans saved money. Lots of it.

The economic data supports this view. During the onset of the COVID-19 crisis last year, savings rates spiked across American households. Individuals were saving at the fastest rate in history due to the economic fear from the pandemic and due to an inability to shop in stores due to the nationwide lockdown. This, along with stimulus checks from the CARES act, likely helped many to weather the storm. Although savings rates have fallen since then, they are still much higher than the historical average.

American savings rates spiked in 2020

Clearnomics chart 01 120 20
The average American household saved 33% of their paycheck during the first month of the COVID-19 crisis. Source: Clearnomics, U.S. Bureau of Economic Analysis, November 2020

Saving even small amounts can add up over time

Cash can serve a very important purpose in your overall financial portfolio by providing “liquidity.” This is simply the idea that you need to have enough cash to cover regular expenses, upcoming purchases, emergency spending, etc. – especially during difficult economic times. For instance, if you’re saving to buy a house or need to repay student loan debt, you don’t want to be forced to sell stocks or bonds to make these payments or expose these funds to market risk. Doing so may not only likely incur a tax bill, but a short-term decline in the market could jeopardize your ability to make these payments.

The prices of stocks and bonds can experience large swings each day, but the value of cash is relatively steady. Thus, having a sufficient amount of cash saved can act as a cushion for your portfolio and allows you to pay short-term expenses. You can add funds to an investment account simultaneously but it’s always good to build cash savings for emergencies.

Additionally, not only will cash retain its value even if stock prices fall, but may even give you the option to invest at a lower price when the opportunity arises. Thus, it can help by providing the option to grow your portfolio even faster. Tools such as dollar-cost averaging can help to maintain sufficient cash while investing steadily over time.

Finally, cash can generate short-term income. Savings accounts and certificates of deposit (CDs) can earn interest with low levels of risk. CDs may reduce your liquidity somewhat by locking up cash for a period of time so it’s important to weigh the various benefits of cash.

Plan for success: Put your savings on autopilot

Perhaps the best approach to building a financial cushion – as is the case with investing in general – is to set it on autopilot. Automatic deposits into a savings or investment account can reduce the urge to spend and can compound over time. Doing so steadily can help to ensure that you have a rainy day fund the next time an emergency or a surprise large expense pops up. 

Thus, there are many reasons to hold cash as part of your financial picture. In fact, it’s good to think of cash as just another asset class – one that can balance the risks of other investments, generate income, and help you achieve your financial goals.

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