The Hidden Costs of Holding Too Much Cash

Are you holding too much in cash, CDs, or money market accounts? If so, this newsletter is for you. I will be covering the real cost of keeping too much cash on the sidelines.

To start, I generally recommend keeping 3 to 6 months’ worth of living expenses in cash or cash-like accounts. This number can be relatively large for those with higher monthly costs and that’s perfectly fine. But the issue we’re focusing on is when people hold far more than that.

Here’s the problem.

Inflation eats into your savings, the IRS takes a cut of your interest and you’re left with what remains which often isn’t much.

Here is a common example:

Let’s say you keep $100,000 in a CD earning 4% per year. That sounds like a nice, risk-free return of $4,000.

But here’s what it actually looks like - If prices go up 3% from inflation, your before-tax gain ends up being only around 1%.

 Interest from CDs is fully taxable. In this example, you could lose $1,000 (25%) or more in taxes, depending on your income and state of residence.

So, after inflation and taxes, your “safe” return might actually leave you barely breaking even or even losing ground.

Meanwhile, banks are using your money to make loans at twice the rate they’re paying you…

And over time, the real damage is not just the shrinking value of your money, but the missed opportunity to earn more by investing. In my experience, in the long run, people who stay too heavy in cash often miss out on $10,000s or even $100,000s in potential growth.

So what are your options?

The most obvious is to invest your excess cash. A diversified investment portfolio can earn 6% or more over time and you can do even better with smart, calculated risk.

Not ready for that? Not a problem. You can also look into Treasury or municipal bonds which often have better tax treatment and slightly better yield.

Dividend-paying stocks are another good choice as they tend to be more stable than non-dividend stocks. Plus, dividends are often taxed at lower rates than CD interest.

Over the long run, these not-so-small differences can add up to real money.

The Bottom Line

Keep 3 to 6 months of expenses in cash (or up to 12 months if you prefer to be cautious). If you’re holding more than that in cash or CDs, it may be time to rethink your strategy. Don’t let your hard-earned money just sit there while inflation and taxes chip away at it.

There are smarter ways to put your money to work.