The trouble with having too much cash

By Vanguard

Investing strategy

Investors with large cash holdings should keep an eye on falling deposit rates.

Most of us have heard the saying, cash is king.

It relates to the liquidity advantages of having an amount of cash readily available to cover off things such as everyday living costs, potential emergency expenses, or on an investment level to take advantage of asset buying opportunities.

Monthly data released in February by the Australian Prudential Regulation Authority shows authorised deposit taking institutions (mainly banks) had close to $1.6 trillion in household deposits on their books at the end of January 2025.

A large component of this cash stockpile is owned by Australia’s contingent of self-directed superannuation investors.

Separate data released by the Australian Taxation Office in February shows self managed super funds (SMSFs) were collectively holding over $161 billion in cash and term deposits at the end of last year.

This equated to around 16% of the just over $1 trillion in total assets being managed by SMSF trustees on 31 December 2024.

SMSFs remain attracted to cash

Cash and term deposits have long been one of the biggest investments for SMSFs, second only to listed Australian shares (which at 31 December 2024 accounted for $277.6 billion in investments and 27.3% of total SMSF assets).

That can partly be explained by the fact that 35% of current SMSF members are fully retired and are likely to be progressively drawing on their cash reserves through account-based pensions. A further 9% are partially retired, according to the ATO’s 2022-23 annual statistics.

But SMSF trustees and other investors may want to take heed of recent cuts to savings interest rates.

Holding large amounts of cash over time, especially during a falling rates environment, can come at the cost of long-term underperformance and failure to achieve long-term financial goals.

As the Reserve Bank of Australia (RBA) announced a 0.25% cut to its cash rate in February, many mortgage lenders were quick to declare they would pass on the full rate reduction – some immediately, others within weeks.

Yet, just as variable mortgage rates are being cut, so are the rates being paid by financial institutions on cash being held in their savings and term deposit accounts.

In fact, many account rates have already been reduced. Dozens of banks and other financial institutions began cutting their deposit rates in February, some of them weeks before the RBA’s rate cut announcement.

Financial comparison site Canstar notes that 20 banks had reduced term deposit rates ahead of the RBA’s cash rate decision, with cuts of up to 0.95 percentage points. Others have followed since.

Term deposit rates have trending downwards since mid-2023. Canstar’s database shows the highest 1-year term deposit rate was 5.45% until July 2023 and the highest 2-year rate was 5.35% until December 2023.

Since then average term deposit rates have dropped below 5%, with promoted rates out to two years currently between 3.90% and 4.60%.

Balancing risk with return

Holding cash can provide a sense of security to investors because of its low volatility (together with the Federal Government’s Financial Claims Scheme guarantee for deposits up to $250,000 in the event a financial institution fails).

However, it’s also important to consider that holding large amounts of cash over time, especially during a falling rates environment, can come at the cost of long-term underperformance and failure to achieve long-term financial goals.

Consider that the average annual return in Australia from cash over the 30 years to 30 June 2024 was just 4.2%, which compared with 5.6% from Australian bonds, 7.8% from Australian listed property, 9.1% from Australian shares, and 11.1% from U.S. shares.

Vanguard’s approach to assessing how much cash might be appropriate to hold is built on the relationship between your goals and risk tolerance, time horizon, and funding level.

Risk tolerance relates to how much market risk you are willing to take on, based on your personal needs.

Risk and return are a trade-off. Therefore, in many cases, including cash not only moves a portfolio toward the more conservative end of the risk spectrum, it also moves it toward the lower end of the expected return spectrum.

Time horizon is the length of time you aim to keep your money invested. The shorter that period is, the less likely you are to benefit from holding riskier assets like bonds and shares.

That’s because, over the long term, the returns of those riskier assets tend to be higher than those for cash, on average.

However, this comes with the drawback of those assets being more volatile, which can mean potentially negative returns over the shorter term.

Funding level is how close to fully funded an investment goal is. If you are close to fully funding your investment goal you may be comfortable with some allocation to cash.

On the other hand, if you are far from reaching your investment goal you may be willing to allocate more to riskier assets for potentially higher returns to improve your chances of success, especially if you have a longer time horizon.

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^{This information has been prepared by Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263). We have not taken your objectives, financial situation or needs into account when preparing this information so it may not be applicable to the particular situation you are considering. You should consider your objectives, financial situation or needs, and the disclosure documents for any financial products before making any investment decision. Before you make any financial decision regarding Vanguard’s financial products, you should seek professional advice from a suitably qualified adviser. Past performance information is given for illustrative purposes only and should not be relied upon as, and is not, an indication of future performance. This publication was prepared in good faith and we accept no liability for any errors or omissions.}