Cash is the most liquid asset that you can own. Cash is the only asset class that will guarantee you a return of principal in the short run.
Although cash typically refers to money in hand, the term can also be used to indicate money in banking accounts, Cheques or any other form of currency that is easily accessible and can be very quickly turned into physical cash.
Whether it is a business or an individual, cash flow management and budgeting are very important. You need to be well aware of your cash inflows and outflows at any given point of time.
Without the proper amount of cash on hand, both of these entities can run into major trouble, and even be forced into bankruptcy.
We often wonder where to put our hard-earned money and immediately look to stocks, mutual funds, gold, real-estate property or bonds. While it’s essential that a portion of your Savings goes for retirement, a new house, or kid’s education, it’s just as essential to keep money in liquid, easy-to-access investments that are not subject to marketplace swings or losses. Such investments not only include Bank deposits, Liquid mutual funds but also cold, hard cash.
We often hear the phrase “cash is king“. If Cash is King then why doesn’t it rule? Is holding cash on hand important? What are the important (good) reasons to keep, cash on hand?
Important & Good reasons to maintain ‘Cash on hand’
The reasons to hold ‘cash on hand’ can be better understood with the actual ‘motives’ for holding cash. There can be three major motives for an individual to hold cash;
- Transaction Motive
- Precautionary Motive
- Speculative Motive
Transaction Motive :
- Liquidity : The advantage of cash is that you can spend it however and whenever you want. You can use it to meet your daily living expenses & short term goals.
- When you are making large purchases or down-payments, it makes sense to hold cash or money in near cash.
- You have to hold cash to meet near-term planned and fore-seen expenses.
Precautionary Motive :
- Unforeseen Contingencies: The precautionary motive refers to the tendency of an individual to hold cash, to meet the contingencies or unforeseen circumstances in one’s life. For example: You got to maintain certain amount of cash as an Emergency Fund to meet any medical emergencies.
- Having physical cash on hand (or) money in a bank account allows you to pay for unexpected expenses without reaching for a credit card and incurring high interest debt. (There can be situations where your medical bills might not be covered by your health insurance policy then you can use cash from your ‘Contingency fund’.)
- Once you use cash from your Emergency fund, replenish the fund as soon as possible with Cash.
- Wealth / Corpus Protection : Let’s say you been investing for your Kid’s college education goal for the last 8 years and you have to withdraw the funds to pay the college fee in next 1-2 years. It is prudent to hold the accumulated corpus in cash or near cash avenues. ENcash your investment corpus.
Speculative / Investment Motive :
- You got to have sufficient cash on hand to make the most of any market crashes or any opportunity to own an investment product at a reasonable price. If you maintain a ‘C(R)ASH FUND ‘and If an investment opportunity presents itself, you have the means to immediately invest.
- Without this, you would either be forced to sell shares or other investments, perhaps at a time when the market is down, or forgo the investment opportunity altogether.
For cash to be king ;
- It must be maintained in reasonable levels. As long as you don’t hold too much of it, cash gives you peace of mind and flexibility.
- It must be accumulated prior to a market downturn, not after the downturn. It also has to be spent before markets recover, not afterwards. Yet we see the opposite behavior time and time again. But, do not expect ‘cash’ to be your best investment. An investment environment in which cash is king for any extended period of time is not going to be a good one for investors.
- It must be accumulated as you approach your Financial Goal(s).
While investing should be a part of your long-term financial plan, don’t underestimate the stability and value offered by cash. Else, you may remain to be Asset-rich but Cash-poor.
Continue reading :
- What is Time Value of Money & its importance
- What is an Emergency Fund? | Why, Where & How much to save?
Hope you find this post informative. Do you believe that Cash is King? Kindly share your real-life experiences. Cheers!
(Image courtesy of vectorolie at FreeDigitalPhotos.net)
(Post first published on : 04-January-2019)