The Hidden Cost of Holding Cash

Cash balances have climbed for many investors this year. Research from Avantis Investors shows why that instinct, while understandable, comes with a real long-term cost.

Cash can feel like a safe harbor during uncertain times. But holding more cash doesn’t eliminate risk, it simply changes what kind of risk you’re taking on. According to research from Avantis Investors, the risks investors fear most in the moment aren’t always the ones that matter most over time.

Cash Balances Are Rising, and It’s Not Hard to See Why

Source: Federal Reserve

Cash balances have risen for many investors this year, whether measured by bank deposits or by money market funds as a share of assets. Avantis points to several drivers: heightened geopolitical tensions, including the conflict in Iran and concern it becomes prolonged; renewed inflation worries, with memories of the pandemic-era price spike still fresh; and uncertainty about how much artificial intelligence will ultimately reshape the economy.

If volatility is the main concern, the appeal of holding cash makes sense on the surface. Equities and higher-yielding bonds can see meaningful drawdowns during periods of market stress, and cash yields are more attractive right now than they’ve been for much of the past two decades.

But the decision comes with trade-offs. Allocating more to cash reduces exposure to assets that fluctuate more, which can dampen portfolio volatility. At the same time, it reduces exposure to the assets that have historically generated higher long-term returns. Raising cash doesn’t reduce the risk an investor faces, according to Avantis. It just changes its shape.

The consequences of holding too much cash tend to show up gradually, through inflation, lower long-term returns, or assets that simply don’t grow enough to support future spending needs. These costs rarely arrive as a dramatic headline or a sudden decline. They accumulate quietly, and over long horizons they can matter just as much as a market crash, if not more.

The Long-Term Cost of Holding Cash

Sources: Morningstar, MSCI, Bloomberg and Federal Reserve

Avantis illustrates this trade-off using a traditional portfolio of 70% global equities and 30% U.S. bonds, a risk profile common among U.S. investors, going back to 1970. An investor who stayed fully in that 70/30 mix would have accumulated roughly 26% more wealth than an investor who shifted 10% of the portfolio from equities into cash. Long investment horizons amplify even small differences in expected returns.

That higher ending wealth did come with somewhat larger swings in value. Over the full period, the 70/30 portfolio had an annualized standard deviation of 11%, compared with 9% for the portfolio holding an additional 10% in cash. The gap showed up during downturns too: during the Global Financial Crisis, the largest drawdown difference in the sample, the fully invested portfolio’s maximum decline was about 5 percentage points steeper than the cash-heavier portfolio. Across all major drawdowns, the average difference was closer to 3 percentage points.

The reason comes down to what each asset actually represents. Cash generally earns a short-term interest rate, while equities represent ownership in businesses whose earnings can grow over time. As those businesses reinvest, innovate, and expand, investors participate in that growth through higher earnings, dividends, and stock prices. Cash offers no equivalent growth engine.

Why the Odds Favor Staying Invested

Sources: Morningstar, MSCI, Bloomberg and Federal Reserve

Small return differences compound into large wealth differences over time, since each year’s gains build on a larger base. That’s part of why the performance gap between equities and cash tends to widen the longer you hold.

Avantis’s research bears this out. Global equities outperformed cash in 68% of rolling one-year periods, 72% of rolling five-year periods, and 89% of rolling 10-year periods going back to 1970. The pattern held up across different markets, currencies, and time periods, and it got stronger, not weaker, as the holding period lengthened. Over rolling 10-year periods specifically, global equities produced roughly 103 percentage points more cumulative return than cash on average.

If the historical evidence is this consistent, why do so many investors still raise cash allocations during uncertain periods? Part of the answer is behavioral. Investors don’t experience every kind of risk equally. A market decline is immediately visible, it shows up on account statements, dominates headlines, and triggers a real emotional response. The cost of holding too much cash, by contrast, is rarely visible in the moment. Few investors ever see a statement showing the wealth they gave up by staying too conservative.

That asymmetry makes cash feel tangible and immediate while its true cost stays abstract and deferred. It can make a decision that reduces short-term anxiety feel prudent, even when it reduces the odds of reaching long-term goals. This is closely related to why reacting to short-term uncertainty by making defensive moves rarely pays off: shifting heavily into cash during uncertain periods is its own form of market timing, and treating cash as a substitute for a properly diversified portfolio just trades one concentration risk for another.

The Bottom Line on Holding Cash

Cash has a role in a well-built financial plan, particularly for near-term spending needs or as a volatility buffer. But treating cash as a default response to uncertainty carries its own long-term cost, one that’s easy to underestimate precisely because it doesn’t show up right away. As Avantis’s research shows, the safety cash offers is real, but so is the price of relying on it too heavily.

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Frequently Asked Questions

Is holding more cash actually safer for my portfolio? Not in every sense. Cash reduces short-term volatility, but it also reduces exposure to the higher long-term returns that equities and bonds have historically provided. Raising cash allocations doesn’t eliminate risk, it shifts it from short-term volatility risk toward long-term shortfall risk.

How much can holding extra cash cost an investor over time? Research from Avantis Investors found that an investor who shifted 10% of a 70/30 equity/bond portfolio into cash since 1970 ended up with roughly 26% less wealth than an investor who stayed fully invested, due to the compounding effect of smaller annual returns.

Does cash ever outperform stocks and bonds? Over short periods, sometimes. But the data shows the odds shift meaningfully with time: global equities outperformed cash in 68% of rolling one-year periods and 89% of rolling 10-year periods since 1970.

Why do investors increase cash holdings during uncertain times? Largely for behavioral reasons. Market declines are immediately visible and emotionally charged, while the long-term cost of holding excess cash accumulates quietly and is rarely visible on an account statement.

As always, CAM Investor Solutions is here to help.

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Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your account holdings correspond directly to any comparative indices or categories. Need to add more disclosures.

About CAM Investor Solutions

CAM Investor Solutions, a fee-only independent Registered Investment Advisor, has offices located in Colorado, Florida, and Texas. As a growing wealth management firm, we focus on the needs of our clients to improve their quality of life. Our firm’s commitment to innovation through rigorous academic research enhances how we serve a multi-generational audience.

CAM’s Specialties Include:

• Managing concentrated wealth
• Planning for stock and option compensation / company IPOs 
• Advanced tax managed investment strategies
• Custom retirement income strategies
• Cash management

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CAM Disclosure

SOURCE: Bloomberg, Avantis Investors, MSCI, Morningstar, The Federal Reserve.

M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. 

This blog has been provided solely for informational purposes and does not represent investment advice. Nor does it provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy.

Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.