Your Cash Reserve
Everyone needs a cash reserve or ‘rainy day’ money.
This is a base amount of money which you retain in a daily-access bank account without any fees or investment risk. In urgent cases when you have to pay immediate expenses, you will rest assured that you can meet the cost quickly and comfortably.
The downside is that this money does not make you much in terms of investment return. And that is okay. These funds should not be seen as an investment asset, but as a trade-off of investment returns for easy access and security. The security in having this money set aside is a positive factor, the sole purpose being to be available when you need it. It is of no value to risk it in the share market or to worry about it not earning enough
Here is a comparison calculation:
Your cash reserve might be $20,000. Let’s say it earns 2.5% interest per year. This equals $500.
If it were to earn 7% (for example) invested in growth assets, the annual interest would be $1,400.
On one hand, the trade-off is easy to measure; it is $900. However, with the growth asset investment you would be taking on far greater risk and your access would not be as good as with the bank account.
As with most aspects of financial planning, the decision is much easier if:
you are clear on what you want to achieve
you do your analysis well
you understand and are aware of the consequences of the alternatives
If giving up $900 on $20,000 per year doesn’t sit well with you, another option would be to reduce the size of your cash reserve to reduce the amount of interest that you would be foregoing.
However, for me, this is not the area to chase returns. You can’t have every dollar running hard and risk it all crashing. You do need some portion to be slow and steady.