The role of cash in personal finance

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Cash is one of the foundations of your personal finance plan. Nothing happens without cash, its what we are trying to save, and get the most out of. Although cash has gotten a bad reputation. Many expound that cash isn’t useful unless its in a growth vehicle such as stocks or real estate because its not growing fast enough. Cash loses its purchasing power due to inflation. But the biggest problem for the lack of understanding of the role cash plays in personal finance.

The role of cash is to handle day to day expenses. Without cash you can’t pay your monthly bills and expenses. Cash is liquid and flexible, there are many situations it can be used. This liquidity is so well known that people always refer how their cash is tied up in investments. When you liquidate an investment you lose out on any potential gains. Now lets take a literal example of this. For example a stock over the course of the year will gain 50%, going from $10 to $15. You have invested all of your unused cash into the stock, but you run into some bills you need to pay. Then because you had put all your cash to “work” you need to take some of the cash out. When you sold the stock was only at $10.50, not only did you lose out on the future gains, you were late on the bill because you weren’t able to access the cash quickly. Now lets consider the same situation but the stock didn’t rise, it fell and sits at $9.50. In this case you lost parts of your initial investment because you had to sell at $9.50. You had to pull more than you expected to cover the loss and now your investment and cash both suffered.

So what can we learn from this? First, you need to treat cash as your asset to handle day to day expenses. So you should always strive to have enough cash on hand. Second, the person in the example needs to be more aware of their investments. Yes, investing in real estate and stocks are great ways to grow your wealth, but they are also very fickle and can rise or fall quickly. They need time to grow, if you don’t have time to wait, then your cash shouldn’t be in the investment. In our example there was a small loss, but large losses are equally likely to happen. Lastly the fear of losing purchasing power due to inflation is something many people have. This is where great personal finance skills are vital such as budgeting to get the most out of your money. You as an individual are likely not going to have enough of an effect to alter inflation rates, it is up to you to handle the changes to the best of your ability.

Cash is king when it comes to persona finance. But when you don’t think about how cash works or the best ways to use it, you will never get as far as you could, if you planned accordingly with your assets.