I have a cash problem.  Instead of investing it all according to my asset allocation, I stash it in a low-paying money market or CD.

I share this bit of shameful information to show how difficult it is to make sound financial choices even when we have the knowledge. Financial success is more about habits than knowledge. That’s why paying yourself first through automatic deductions is a key to wealth building. If you don’t have to make the decision to invest, you will invest. If it’s up to you to pull the trigger, your pesky brain gets involved.

Why do I hold cash?

There are two reasons I hold cash. One, I’m doing a Cardinal sin of smart investing: trying to time the market. I keep thinking our market is over-priced, and I’m certainly not the only one. Nobel Prize in Economics winner Peter Shiller thinks so too. His cyclically adjusted price-earnings (or CAPE) ratio shows stocks are dangerously overvalued. It’s value of 30.64 is around the same level as pre-crash 1929. It’s only ever been higher during the dot.com boom of the late 90s.

In a CNBC interview, Shiller himself urged people to reduce stock holdings:

The current level of the CAPE ratio “would suggest reducing your holdings of stocks, especially for a long-term investor. We can’t time the market accurately, but we know that when it’s this high, over the long term, it usually doesn’t do great.”

The only problem? That was in February of 2017, when the CAPE ratio was at 28. The S&P index has risen 7.14% since February, 7.85% when dividends are reinvested. Compare that to the 1.1% I earned in a money market (pre-tax). Of course there is much more risk in VFINX than the insured return from a savings account. The point is trying to time the market, even if you have a Nobel in economics, is futile.

Yet I still do it.

The other reason I hoard cash is risk avoidance. For years, I was a contractor and responsible for my own tax with-holding, so I would save 40% of checks to be sure I had enough to pay the tax man. Then I started saving for a down payment of a house, which in the Bay Area is six figures. I didn’t want either of those buckets to be at risk, so cash made sense. Habits are hard to break, and it’s difficult not to worry about the money you are relying on for future. After the downturn of 2008, investments suddenly shrinking is not an abstract notion. The only problem is inflation will eat up cash that’s not invested. Nothing is risk free. A balanced portfolio is certainly smarter and safer than holding too much cash.

What I should do with my cash

Here’s the best approach to a cash position in your investments:

  • Hold a six month emergency fund in a safe savings, money market account. The fund should equal six months of your expenses. If you feel especially comfortable with your job, you may want to do three months. If you’re a freelancer, perhaps nine months is better.
  • Put it in a separate savings account. The best deals are digital banks like Ally or Capital One where you can access the funds relatively quickly but not immediately. Both are paying 1.2% right now which is better than nothing.
  • If you’re actively saving for a down-payment on a house or something large like a car, keep the cash in a separate savings account or at least track your goal so you don’t over-save. Set a time-limit for using the money. If you don’t use it, invest it. You may want to ladder CDs at one of the above banks.
  • Any excess cash should be invested monthly into your asset allocation: tax advantaged accounts like 401ks and IRAs first, and then a taxable brokerage account. Use a robo advisor like Schwab’s Intelligent Advisor if that makes it easier for you. Or keep it simple and invest in VTSMX or another low-cost total stock market index fund. While gallons of digital ink can be spilled on these subjects, I think the most important point is just to invest in something you can set up easily, that will be taken out without your intervention.
  • If you are very risk adverse, consider holding more cash in your asset allocation. Just be intentional and mindful of the risks and rewards of your choices.

So what about me? I’m dollar-cost-averaging some of the cash into my accounts monthly, but still keeping extra cash. Habits and emotion are hard to break! I do think the market is over-valued, and we’re soon in line for a correction. And while I’m not selling anything, (and didn’t during the crash of 2009) I do think that I will use the impending dip to redeploy cash. I’m not the only one thinking this, of course, but as I’ve shown above, it’s a fool’s errand to try to time the market. Nevertheless, I persist, despite my own advice. Nobody’s perfect.

What percentage of your asset allocation is in cash?