Comfort Cash

Bob Stowe |

Last month I sent an article about a reluctance to invest, which causes cash accounts to build up. This prompted a number of replies. “You are talking about me aren’t you” or “do I have this problem?”

To be specific, the issue I discussed is a reluctance to invest money that should be invested. The money has a purpose in the plan as a long term investment funding long term goals but not as a cash account earning no interest. However, there is a corollary situation sometimes called ‘comfort cash’ that affects many investors. This is a local savings account, CD or money market account that holds enough money to make the owner feel financially secure. It typically is the source of spending for the near term, but not always.

Comfort cash is a real thing. A recent study of bank customers in the UK links the amount of cash in the bank to a sense of financial well-being, which is different from satisfaction with life or overall happiness. The survey identified how financially secure people felt by holding cash. The survey controlled for other variables such as age, employment, relationship and overall wealth. Regardless of these other factors people had a positive response to more rather than less cash in the bank. The response was not linear but logarithmic. This means that there was as much utility increase in moving from $1 to $100 as in going from $10,000 to a $1,000,000. A different way of saying it is that doubling your savings does not double your satisfaction with having more.

One assumes this is intuitive, but all people do not perceive the security of cash in the same way. One would think that age would be a good indicator but this is not what my experience tells me. An optimistic 80 year old with a secure cash flow should have no more desire or utility for cash than a 30 year old. Another 80 year old of similar circumstance might decide that there is no investment risk worth taking due to her perception of a limited investment horizon (short remaining life) and may want to hold all her money in cash, preferably in 10’s and 20’s.

There are circumstances where comfort cash makes sense. A salesman with uneven income would have a large savings or money market account, as would any older household (single or couple) with only one highly compensated worker. Anyone anticipating higher near term expenses or a big ticket item like a house down payment or college would naturally want access to more cash. There are other circumstances where this would be warranted as well. If it covers spending for the short term or makes up for an income loss, then cash has a purpose.

There are other implications for financial planning, such as:

  • Does a lack of cash on hand make an investor more likely to panic in a volatile market? How liquid does the investment have to be to satisfy this need?
  • Are short term bonds in your account a good substitute on a psychological basis, as there is practically no difference in risk?
  • What about the investor who holds large amounts of debt while insisting on having zero interest savings? 

Portfolio performance suffers, but your financial well-being increases. Reconciling the paradox is part of planning.