As an asset class, cash generally elicits one of two responses from investors: “cash is king,” or “cash is trash.” Most of your clients are probably in one camp or the other, while some could be conflicted. On one hand, they may see the positive benefits of holding onto cash — shielding against the unexpected or having more flexibility to invest as opportunities arise. On the other hand, they may harbor a genuine fear of missing out on possible investment returns and resulting portfolio growth.
Each client’s situation is unique, and where they are on their financial journey plays a role in their investment philosophy. Those nearing retirement may need access to uninvested assets sooner, and cash may be an attractive option. Clients with long-term investment horizons or anxiety around market volatility might regret shifting from investments to cash. Whatever the situation, clients may turn to you for objective clarification and guidance.
This gives you a chance to discuss how it’s possible that cash may be viewed as neither “king” nor “trash” in terms of investments, but rather as an important piece of a healthy, well managed portfolio:
- Cash provides liquidity. Having cash available within a portfolio ensures that investment fees, portfolio rebalancing, and other periodic or recurring expenses are covered without disrupting target asset allocation.
- Cash provides flexibility. Inflation and deflation notwithstanding, cash assets retain a relatively steady value. This helps stabilize and lessen the impact of market volatility on portfolios, and could put clients in a position to buy stocks at lower prices, if desired, during market downturns.
- Cash provides low-risk returns. Instruments such as money market funds, bank accounts, or Treasury securities are extremely low-risk investments. But the tradeoff for clients is typically modest returns, especially when compared to stocks and bonds.
For all the potential benefits, investors should exercise caution when considering cash — especially clients nearing retirement. While that timeframe generally triggers a more conservative asset allocation, shifting too far into cash holdings might limit portfolio growth potential and ultimately jeopardize long-term financial security.
The Annuity Alternative
Cash assets have pros and cons, leaving clients with a lot to consider. For those who remain undecided about how cash allocations benefit them, annuities may offer a practical strategy. By balancing risk and reward, annuities provide clients with the stability and control of cash without having to sacrifice portfolio growth potential or future income.
With today’s low interest rates on traditional savings accounts and CDs, annuity products may offer greater returns that are guaranteed for life. Unlike CDs which typically only pay out once they mature, annuities can provide regular monthly income at a fixed rate — payments that will never run out.
There may be tax advantages to annuities as well. Your clients will pay taxes on any interest earned during the year on a regular savings account. With annuities, income taxes are paid on annuity interest in the year your client actually withdraws from the account. Make sure your clients are aware, however, that any annuity payments received before age 59½ may be subject to an additional 10% tax on early distributions (in addition to potential surrender fees), unless they qualify for an exception.1 Such a penalty could negate or significantly diminish any potential gains.
And let’s not forget about how potential inflation rates combined with low interest earnings on savings accounts may overshadow any gains and even result in negative returns.
Maintaining liquidity for a portion of assets is generally a practical strategy, but keeping large portions of cash in accounts with low interest rates may mean your clients could miss out on greater gains.
Of course, there are no cut-and-dried answers, and many of today’s investors have complex situations that require highly nuanced strategies. Use our ElevateTM Advanced Planning Resources to help your clients navigate complex scenarios, including annuity considerations, legacy planning, rollover options and more. Simply click the button below to access this library of helpful content.
1Internal Revenue Service, Topic No. 410: Pensions and Annuities, March 12, 2021.