Monday, July 22, 2024
Home Personal Finance Having cash can make you poorer in many ways – be careful

Having cash can make you poorer in many ways – be careful

by xyonent
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During the recent liquidity crisis, I kept thinking about how nice it would be to have more cash in my bank account. When I received a $106,000 real estate capital distribution, I felt a great sense of relief. But then I was faced with the somewhat stressful decision of how to reinvest it.

My private real estate fund invested $47,000 of my capital in a deal 7 years ago. This deal achieved an internal rate of return of about 12.2% and led to a capital distribution of $106,000. For 7 years, I never thought about the $47,000 investment, but suddenly the distribution came. It was nice, and that’s one of the main reasons why I prefer to invest up to 20% of my capital in private funds.

But let’s talk about how having cash can make you poor if you’re not careful, which is a bit ironic with all the talk about cash being king.

Why it’s bad to have too much cash

There are essentially three reasons why you might want to keep cash to a very small percentage of your net worth: Let’s expand on each one.

1) Cash is bad for you in the long run

If you look at my net worth allocation model, I would recommend holding less than 5%-10% of your net worth in cash, depending on the economic cycle and your personal financial situation. The reason is that cash has historically underperformed most assets. Cash only tends to outperform during economic downturns.

Fortunately for investors in stocks, real estate, and other risky assets, these assets almost always tend to go up. Stocks have roughly a 70% chance of going up in any given year, and real estate is an even more stable asset class, so the chances are even higher.

So if you hold a lot of your net worth in cash, over time you’re likely to fall behind others who have more of their cash invested in risky assets.

Money market funds, a safe place to store your cash, may offer higher interest rates at times. However, the interest rates on money market funds reflect the interest rate and inflation environment. When holding cash in a money market fund, it is important to calculate the real interest rate (nominal interest rate minus inflation).

2) There are too many temptations to waste money on things you don’t need.

If you suddenly found yourself with a lot of money, over $100,000, you might be tempted to buy a lot of things that won’t help you grow your wealth.

Maybe you buy an $80,000 luxury car when a $25,000 car would suffice. Maybe you’re tempted to buy a $22,000 Rolex Stainless Steel Daytona when an iPhone would suffice. Or maybe you violate my vacation spending guide and spend $40,000 on a two-week family trip to Hawaii that should have cost just $10,000.

Saving and investing your extra income is easy to say, but it’s much harder to do than it sounds.

There’s a reason why people regularly spend their tax refunds on things they like: they view the money as a bonus, not their own money.

There’s a reason the average net worth of a homeowner is much higher than the average net worth of a renter: forced savings save homeowners from bad spending habits.

The Buddha said, “Desire is the cause of all suffering.” If you have a lot of money, you may end up fulfilling many desires and become poorer instead of richer.

3) It’s very difficult to invest large amounts of cash

Dollar-cost averaging is one of the best ways to invest for the long term. All you have to do is continue to invest a set amount at regular intervals, regardless of the state of the stock market. With dollar-cost averaging, you don’t have to guess when to invest.

But when a large amount of cash comes your way, investing it can be much harder than your normal monthly cash flow. This is especially true if the new cash infusion comes from a long-term investment that’s been doing well. The last thing you want to do is reinvest your earnings and wipe out all the gains from your previous investments.

Since starting Financial Samurai in 2009, I have met and counseled many individuals with huge cash balances (sometimes as much as 30% to 70% of their net worth) and when I ask them why they don’t invest their cash, they almost always say they don’t know what to invest in. The reality is, they’re too afraid of losing their hard-earned money.

I have been investing between $5,000 and $20,000 per month for the past 20 years, so investing the $106,000 in windfall income from estate distributions is more than five times my usual amount.

Since my real estate investments spanned seven years, I was worried that I would lose my profits quickly on one investment. Everything from the stock market to real estate was recovering from lows. As a result, I decided to carefully invest $1,000-10,000 per deal for the next two months.

I bought stocks with my extra income.

Here is a spreadsheet I downloaded from Fidelity that shows some of the stocks I purchased in my real estate capital allocation. Essentially, over a three month period, I purchased the Vanguard Total Stock Market Index Fund ETF and growth stocks like Amazon, Apple, Nvidia, etc. The last two columns are the number of shares purchased and the stock price.

Reinvest the cash from your real estate income into stocks
Having cash can make you poor in many ways if you're not careful - Reinvesting your real estate dividends into stocks

This wasn’t a machine that entered orders based on some algorithm. It was me buying stocks multiple times a week when the time seemed right. It was both fun and exhausting. Managing a family’s finances can sometimes feel like a full-time job.

If I wasn’t afraid of losing money, I would have reinvested all $106,000 within a week. But in investing, nothing is ever completely certain. Instead, you develop an asset allocation framework and an investment thesis. Then you have to have the courage to act on it and invest.

Thoughts on why I bought these stocks

VTI is the stock I default to in this taxable portfolio if I can’t think of anything else to buy. I’m using VTI to build exposure to publicly traded stocks, which decreased after purchasing a home.

Apple is a stock I’ve owned for over 12 years and continue to buy. I bought more before the developer conference as I believe Apple will have a big win in artificial intelligence. Since you need the iPhone 16 to run Apple Intelligence on mobile, I think the upgrade cycle for the iPhone 16 will be stronger than expected.

I’ve owned Amazon for over 12 years and have been buying more shares this year as the company has lagged other big tech companies. Interestingly, I actually just met Amazon CEO Andy Jassy at a party last week and thanked him for his contributions.

I have held Tesla since 2016 but sold a large amount to buy a house in 2023, so I am in the process of re-positioning after the sale. Competition in EVs is intense, but I think Tesla will come out with a successful new model, which will cause a re-evaluation of other businesses.

Gradually increase your exposure to AI

Over the past two years, I’ve been increasing my exposure to publicly traded artificial intelligence companies, which is why I bought Nvidia, and I’ve also built significant positions in private AI companies, as the longer the companies remain private, the more profitable they are for private investors.

artificial intelligence

The easiest way to gain direct exposure to private AI companies is to Fundrise Venture ProductsSo far, I have invested $143,000 into this product and plan to invest even more in the future.

Now I’m hoping these investments pay off in the long term. Intention There may be a correction ahead, but I intend to hold these latest investments for many years.

As always, there are no guarantees when investing in risk assets. Please exercise due caution and only invest what you can afford to lose. These are investment decisions based on my financial situation and risk tolerance and are not recommendations to you.

If you don’t have much cash, you need to focus on your finances

One of the most significant impacts of having less passive income is that you have to be more vigilant about your household finances. This primarily means monitoring your cash flow, reducing your expenses, forecasting future capital calls, investing more purposefully, and assessing your exposure to risk.

Without a ton of cash sitting in a checking account or money market fund, you’ll be much more motivated to invest aggressively and make more money. As a result, being short on cash could actually make you wealthier. There is no room for idleness Or, if you don’t have a lot of financial leeway, you might miss something.

During the liquidity crisis, I Empower I started depositing money into my account at least twice a day instead of once a week, which looking back, was a good thing because my net worth profile changed dramatically after I bought my home.

As piles of cash grow, the motivation to work hard and invest wisely tends to wane — because why bother if you don’t have to? If you’re a parent, giving your kids lots of money can have a negative impact on their motivation to be self-motivated.

Make cash less useful

If you want to protect yourself yourself To increase your chances of growing your assets, keep as little cash as possible in your main checking account, leaving only enough to cover regular expenses.

Move as much cash as you can into a brokerage account and invest it. This will make it a little harder to access your cash for unnecessary expenses. You can also diversify your cash into other investments like private real estate or venture capital, which will make it even harder to access your cash.

My 2017 private real estate investment saved me in 2024, and I expect many other past private real estate investments will also save me in the future, as I have continually invested most of my free cash flow each year.

Having cash is good, but once you have about six months’ worth of living expenses saved up in cash, you should seriously consider investing it. Your future self will thank you.

Questions from readers

Have you ever come across a large amount of money unexpectedly and spent it on frivolous items? If so, what did you end up buying? Are there other ways in which having too much cash can make you poor? What is your ideal average cash balance?

How to diversify your investments Fundrisemy top pick for private real estate. With over $3.3 billion under management, Fundrise focuses on the Sunbelt region, where valuations are low and yields are high. Invest your cash if you think mortgage rates will fall and shift to lower-cost areas over the long term.

As always, past performance is no guarantee of future results. Only invest what you can afford to lose and what you do not need. Fundrise is a sponsor of Financial Samurai and Financial Samurai is an investor in Fundrise.

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