When Playing It Safe Backfires: How Too Much Cash Can Hurt Retirement

We recently worked with a couple with 70% of their seven-figure portfolio in cash and high-yield money market accounts, earning around 4.85% on their deposits. Although they understood they were earning less than the long-term potential of 8% to 10% in the stock market, they preferred the relative safety of cash and cash equivalents.

While this is an extremely conservative approach, we can understand their comfort with those rates, as they take on little risk. Since their financial plan showed that they only needed 4.5% growth for their assets to last throughout their lifetime, their reasoning was, “Why take on the risk of investing?”

However, having 70% in cash is far more conservative than we would recommend. The foundation of the Henssler Ten Year Rule is that fixed-income investments should be based on spending needs, not age or an arbitrarily chosen withdrawal rate. We create financial plans that include cash flow projections to determine how much investors should allocate to fixed-income investments to sustain their living expenses for the next 10 years.

A well-constructed financial plan is essential, as being too conservative can be detrimental to an investor’s long-term outlook. At age 70, assets need to last for 20 years or more, and cash may not keep up with inflation. Moreover, the current rates for money market accounts, which range from 4.25% to 5.30%, are not guaranteed. These interest rates and annual percentage yields are variable and can change at any time at the bank’s discretion. It’s worth noting that rates near 5% only began in mid-2023, while just two and a half years ago, they averaged 0.33%.

If an investor is committed to maintaining such a conservative strategy and their assets are projected to last, we recommend locking in interest rates with U.S. Treasury bonds or bank CDs. For instance, a 10-year U.S. Treasury bond purchased today and held to maturity could yield around 3.6% annually. When the Federal Reserve lowers the Fed Funds rate, money market account rates will decrease, but a Treasury bond’s rate will remain locked.

Now, let’s say they run their financial plan, and it reveals that 70% of their assets need to be in fixed investments for the next 10 years to cover spending needs, indicating their plan is likely unsound. They would be drawing down their assets, and the 30% left in growth, combined with the interest earned on their cash, likely wouldn’t be enough to offset their spending, highlighting a clear spending issue.

We’ve seen clients with millions of dollars in invested assets who are in danger of running out of money based on their spending projections. Conversely, we’ve also worked with investors who have saved half a million dollars and are perfectly on track. This situation is independent of age or income; it all comes down to annual expenditure.

This circumstance underscores how crucial spending is to a financial plan, and how essential the plan is in determining the appropriate investment strategy. While we never want an investor to feel forced to sell equity investments during a market downturn to cover spending needs, a 5% return on cash won’t last forever. When the Fed decreases rates, these returns will shrink.

If you have questions on how to manage the fixed-income portion of your portfolio, the experts at Henssler Financial will be glad to help: