There are always two ways for individuals to hold cash. Emergency fund cash and investment cash. Understanding the difference is essential before deciding on the right investment mix.
Emergency cash (not part of your investment portfolio)
Life has a habit of delivering the unexpected, which is why it’s generally recommended to keep around 3–6 months of living expenses in cash, readily accessible in a savings account or mortgage offset account. If your income is variable, or you prefer extra peace of mind, you may choose to hold closer to 6–9 months of expenses.
For those approaching retirement or already retired, emergency cash can also play an important role in covering health-related costs, care services, or short-term living adjustments. Having accessible funds available can reduce the need to sell long-term investments at an inconvenient time.
Other reasons for setting aside cash may include saving for a specific goal, such as a car purchase, an overseas holiday, or a wedding.
This emergency or special-purpose cash is not considered part of your investment portfolio.
Cash as part of your investment portfolio
Once your emergency fund is in place, the next question becomes how much cash should be held as part of your investment portfolio. This may include savings accounts, preferably high-interest savings accounts, or term deposits.
While cash investments are considered very low risk, the interest earned will often lag behind inflation over the medium to long term. This means that even when interest is reinvested, the real value of cash can gradually erode over time.
That said, cash still plays an important role beyond returns alone. It can provide stability, flexibility, and peace of mind. Particularly for those prioritising regular income, access to funds, or lower volatility in their overall portfolio.
Generally speaking, lower-risk investments tend to offer lower returns, while higher-risk assets such as shares may deliver greater growth over the long term. This doesn’t mean cash has no place in a portfolio. Rather, it highlights the importance of balancing growth potential with personal goals and comfort with risk.
Cash equivalents as part of your investment portfolio
Fixed interest investments, including government bonds, corporate bonds, and debentures, are often referred to as cash equivalents. These investments typically carry more risk and are less liquid than holding cash directly, as access to funds may take several days or be restricted until maturity.
However, fixed interest investments usually offer higher returns than savings accounts or term deposits, compensating for the additional risk while helping to preserve capital. For many investors, they can form a useful middle ground between cash and growth assets.
Matching your mix to your investment horizon and goals
With a clearer understanding of what qualifies as cash and the role it plays in a portfolio, the focus turns to finding the right mix. There is no one-size-fits-all solution, as the appropriate balance depends on your investment horizon, financial goals, and tolerance for risk.
For example:
- Younger investors with a higher risk tolerance and long-term goals may hold around 5% in cash, with greater exposure to shares and growth assets.
- Those in midlife, often balancing family responsibilities, may prefer holding 10% or more in cash alongside a more balanced mix of assets.
- Those approaching retirement, or already retired, often prioritise income stability and capital preservation. They may consider holding 30% or more of their portfolio in cash and defensive assets such as fixed interest investments.
Finding what’s right for you
The key to managing cash effectively is to establish your emergency fund first, then decide how much of your portfolio to allocate to cash based on a clear strategy rather than fear or overconfidence. While holding too much cash may limit growth opportunities, having too little can reduce flexibility when circumstances change.
This balance becomes especially important later in life, where access to funds and reduced volatility can help support lifestyle choices, income needs, and potential care requirements.
As priorities change later in life, the right balance between cash and investments can make a real difference. A licensed financial professional can help tailor an approach that supports income needs, flexibility, and peace of mind.
Key facts and figures in this article are sourced from the following:
- Medium to long-term return on cash vs inflation: https://www.alman.com.au/yourmoney/cash-is-kinguntil-inflation-steals-the-crown/ By Alman Partners. (Retrieved 6th January 2025)
- Long-term return on cash vs shares: https://www.fool.com.au/2025/04/28/how-cash-can-make-orbreak-an-investors-track-record/ By Laura Stewart at The Motley Fool. (Retrieved 6th January 2025)
Ascent Wealth Solutions Pty Ltd (ABN 38 685 677 141) is a Corporate Authorised Representative (No. 1314931) of Personal Financial Services Ltd (ABN 26 098 725 145). Australian Financial Services Licence (No 234459)
