How much to invest vs. keep in bank account as passive investor
Whether you invest primarily in stocks, commodities or real estate, it is important to keep a certain percentage of your portfolio in a liquid savings account. The primary benefit of having cash available is that it allows you to quickly buy assets at a discount during a period of economic weakness. Let’s take a look at how much cash a passive investor should keep in the bank at all times.
Do You Have an Emergency Fund?
Before you start investing in stocks, bonds or other passive vehicles, it is important to build an emergency fund. Ideally, you’ll have enough money to cover at least six months of expenses. After you reach that point, you can start to begin to implement your passive income wealth building strategy.
Cash Should Make Up at Least 5% of Your Portfolio
Ideally, you will keep at least $5 for every $100 in your investment portfolio. If you are a passive investor, it might be a good idea to keep even more of your money in cash as you can earn interest and dividends on that money. In fact, depending on your approach to investing, it may be a good idea to put up to 20% of your portfolio in a savings or checking account. As savings account balances of up to $250,000 are insured by the FDIC, opening a savings or checking account can be an effective way to earn passive income while preserving your capital.
There Is a Point of Diminishing Returns
While you can certainly increase your wealth by collecting dividends and interest from a savings account, it may not be the most efficient way to do so. It isn’t uncommon for banks, credit unions and other financial institutions to offer less than 1% interest on money held in their accounts. Conversely, annual inflation in the United States can be upwards of 2% or more.
Therefore, if you kept all of your money in cash, you would be earning less than inflation. In such a scenario, your purchasing power would decrease even if your net worth increased. Historically, stocks have generated average returns of 11% per year while real property prices tend to appreciate by up to 5% annually.
Passive Investing Doesn’t Mean Staying Out Completely
There is a major difference between a passive investing strategy and staying out of the market because you’re scared of losing money. If you have a relatively low risk tolerance, you should consider putting money into government bonds, gold or index funds. You might also want to consider putting money into real estate investment trusts (REITs) that send out regular dividend payments.
Finally, you may be able to build wealth in a conservative fashion by purchasing ETFs. An ETF is similar to a mutual fund in that it allows you to purchase exposure to multiple companies or sectors in a single equity. It is also like a stock in that you can buy and sell your shares during the trading day.
How Long Are You Planning to Keep Your Money in the Market?
Time is a key component to any wealth building strategy. For instance, if you are only a few years away from retirement, you’ll want to take fewer risks in an effort to conserve your wealth. Therefore, it may be a good idea to liquidate equities in favor of cash.
However, if you have several decades before retirement, it’s generally a better idea to invest in riskier assets such as growth stocks or IPOs. This is because you’ll have an opportunity to recoup any short-term losses over the course of 10, 20 or 30 years. In such a scenario, you’ll want to have as little cash as possible in your portfolio.
It’s important to note that these concepts are generally true regardless of what your investment goals are. A financial planner may be able to provide more insight into how to allocate your funds to help meet any specific goals that you might have.
Regardless of how conservative you are when it comes to investing your money, it’s important to limit the amount of cash you have at any given time. Although it is possible to generate a return on that portion of your portfolio, you can grow your net worth faster by putting money into stocks, commodities or real estate. Furthermore, any profits or losses generated by the sale of these assets may receive favorable tax treatment.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.