Have you built up some extra cash? Great job! But don't just stop there - be sure that your savings are being maximised. Here are a few key steps to figuring out what to do with the cash you've accrued:
Cash is great for a few things: everyday expenses, emergency funds (which we define as enough to cover three to six months of living expenses), and goals that are coming up in the next five years.
Holding any extra cash on top of what you need in the near term is known as "cash drag" — cash that is underperforming compared to what you could make if that money were invested. History shows that financial markets rise over the long term, so excess liquidity means you could be losing out on some valuable returns.
As we mentioned above, for an emergency fund and short-term goals (less than five years), it makes sense to hold cash rather than invest it in the markets.
Because the markets are volatile, you could suffer losses in the short-term and not have cash on hand when you need it.
But not all accounts for your short-term cash are created equal. The interest rates of checking or savings accounts can vary widely from a measly 0.01% to a much more attractive 2%.
For your short-term cash needs, we recommend using a high-yield savings account with a high interest rate because it allows you to earn a some return without taking on market risk.
Our top picks:
The rest of the savings that you're holding for long-term expenses (five years or more) could be invested in the market. Which account you choose to invest this cash depends on your goals.
For long-term goals, you could consider passive investing, which means putting your money in a diversified portfolio of low-cost index funds.
Year to year, one asset class may rise and another may fall. But by investing across asset classes you can insulate yourself — to some extent — from losses while tracking the broad performance of the overall markets.
This strategy should be coupled with a "set it and forget it" mindset. In other words, we strongly urge you against trying to time the market. A huge strength of passive investing is that it leaves human judgement and emotion at the door and lets your money steadily compound over time.
Good investing is built on three important principles: diversification, minimising fees, and minimising taxes.
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