Key takeaways
- According to GDP growth metrics, the U.S. is in a recession, but economic indicators suggest we’re not “technically” there
- Recessions often come with higher unemployment, less consumer spending and turbulence or decline in the investment markets
- Many believe that “Cash is King” during a recession – but that may not be true for every investor
Broadly speaking, a recession is a period of economic decline marked by at least two consecutive quarters of declining GDP. Despite achieving that mark already in 2022, Dallas Federal Reserve data suggests we’re not actually in a recession.
But where we are instead isn’t an easy question to answer.
What is certain is that we’re in economically unprecedented times – and there may still be tough times ahead. And in rough waters, people often turn to cash as a safe haven. This has led to the recurrent sentiment that Cash is King during a recession.
Which leads us to our own question: how true is that, really?
What does “Cash is King during a recession” actually mean?
“Cash is king” is a phrase that pops up in business and investment discussions.
Broadly, it refers to the importance of ample cash flow and liquidity for a business, household or portfolio’s financial health. Keeping cash available, especially during a crisis, adds flexibility to any wallet.
For investors, “cash is king during a recession” sums up the advantages of keeping liquid assets on hand when the economy turns south. From weathering rough markets to going all-in on discounted investments, investors can leverage cash to improve their financial positions.
For that reason, investors often add cash to their portfolio strategy during times of financial uncertainty. However, doing so to excess can have unintended consequences.
When cash is king during a recession – and when it’s not
As a consumer and investor, cash seems like a safe investment. And, nominally, that’s true: holding cash means the value of your account won’t suddenly plummet. But relying too heavily on cash can detract from your ability to meet your long-term goals.
To wit, let’s examine seven pros and seven cons of holding cash during a recession.
Pro: Cash means liquidity
One of the biggest risks to individuals in a recession is the threat of job loss or unaffordable bills. With a solid cash account behind you, it’s easier to navigate uncertainty more confidently knowing that you’re financially prepared.
Con: Cash leads to temptation
On the other hand, a major downside of keeping cash is the pure ease with which we can spend it. When recession comes and times get tight, it’s tempting to tap that cash balance for a little relief. A night on the town here, a shiny new device there – those one-time transactions add up fast.
Pro: Interest rates are going up
We’re living in unique economic times. While recessions often come with lower inflation or even deflation, our economy is grappling with a four-decade record high of 8.5% due to ongoing supply chain issues.
Because inflation remains at record highs, the Federal Reserve is fighting back by hiking interest rates. And with higher interest rates on debts comes higher rates on savings and money market accounts. (I.e.: good news for savers.)
Con: Inflation isn’t going down
On the other hand, we’re still struggling with high inflation – and inflation eats cash for breakfast. Even if your savings account sees 2%, 3%, even 4% back on every dollar saved, you’re still losing 8.5% of your purchasing power to inflation. This time around, holding cash during a recession may just mean losing purchasing power.
Pro: Cash accounts are low (or no) risk
Unlike stocks, crypto and other advanced investment instruments, most cash-based accounts offer insurance to protect your cash. Not to mention, depositing $100 today means seeing that $100 in your account tomorrow – not a guarantee you’ll find in the stock market.
Con: Insurance limits
The longer you hoard cash in a bank or brokerage account, the more likely you’ll eventually bump into insurance limits. Generally, insurance only pays up to $250,000 per person, per institution, or $500,000 per joint account. If you save more than the limit and the institution goes belly-up, you may be out the rest of your balance.
Pro: Extra cash means more money to buy the dips
The more cash you hold, the more liquidity you have to snap up great opportunities as they come along.
For instance, when the housing bubble burst in the mid-aughts, real estate prices plunged by a third nationwide. For house flippers and real estate investors with cash on hand, that left tons of cheap property up for grabs. (Just imagine if you’d purchased a house in the Great Recession and sold it at the peak of last year’s frenzy.)
And it’s not just real estate. When a recession comes around, the price of everything from stocks to bonds to commodities can drop. Keeping cash sidelined means that when these opportunities knock, you’re there to answer.
Con: Knowing when to buy is iffy
On the other hand, waiting for said opportunities is easier said than done. It’s impossible to truly recognize a good opportunity until after it passes. With cash waiting in the wings, it’s possible you’ll act too early, too late, or even not at all – leaving you with a portfolio full of cash and no great gains to show for it.
Pro: Cash doesn’t have to mean cash
Adding cash to your investment strategy adds diversity, and diversification is a crucial component to investment success. (Plus, a little liquidity lets you correct your percentages if you stray too far from your diversification goals elsewhere.)
But it’s more than that: in the investment world, cash doesn’t have to be cash. Rather, cash can be any (relatively) safe investment that you can cash out quickly.
That means money market accounts and mutual funds, certificates of deposit (CDs), Treasury bills and other short-term, interest-bearing investments. Each of these boosts your diversification and adds interest to your portfolio – without navigating the risks of a recession-era stock market.
Con: Cash costs opportunities elsewhere
However, letting cash sit idle anytime – recession or not – means losing out on potential returns elsewhere. That’s an unfortunate trade-off that investors and savers make constantly: the battle between higher returns later and financial security now.
Not to mention, excess cash holdings means less capital percolating in the markets, which may lower your long-term returns.
Pro: Stocks tend to suffer in a recession
Put bluntly, cash can help during a recession because it’s not stocks. While the stock market often picks up steam during the recovery phase, during the recession itself, stocks may plunge to new record lows or stagnate. Keeping cash on hand means you won’t have to worry about selling at a loss to cover emergency expenses.
Con: Cash misses out on opportunity
Recessions are risky for investors. Often, the value of the stock market declines into bear territory or lower, which means buying in or cashing out at the wrong time costs you capital.
However, you need that risk to beget returns: some of the riskiest investments have a chance to capture the highest rewards. Taking a conservative tack and holding too much cash risks misses this volatility. By the time you hear about economic or stock volatility or growth, it may be too late to catch your share.
Pro: Dividends offer unique opportunities
Okay, so, we’re cheating with the dividends here – but it is a sweet cash-adjacent perk.
Many modern companies and brokerages offer the opportunity to opt into dividend reinvestment plans (DRIPs) on dividend-paying stocks. DRIPs take the dividends your investments generate and plow them right back into your portfolio.
During a recession, you can use this source of cash to increase your holdings without pulling from your own pocket. (That’s before considering that the stocks themselves might be trading at a discount.)
Con: Cash-based returns may be taxed sooner
Though it doesn’t boast the same returns as, say, the stock market, cash can generate profits via interest and dividend payments. A tidy nest egg can produce tidy returns for your wallet and the IRS.
Unfortunately, the IRS demands payment on interest earned, even if you leave the cash in your account. By contrast, you don’t have to pay taxes on stock price appreciation until you’ve sold your holdings and incurred capital gains.
When is that much cash too much cash?
Compared to investments like stocks and real estate, cash is a relatively low-risk, low-return investment. Holding too much can hamper your long-term financial growth – but holding too little leaves you clutching an empty bag when crises emerge. (We’re picturing a rather sad Monopoly man over here.)
Saving for emergencies
Generally, financial experts recommend that households save anywhere from 3 months to 1 year of living expenses in cash on top of whatever’s in your portfolio. The number varies based on age, income, expenses and financial situation.
For instance, single-income households, freelancers and entrepreneurs may be encouraged to save more in case the worst comes to pass. But for dual-income or higher-earning households, the standard 3-6 months may be plenty.
And as you approach retirement, the recommendation rises to 1-3 years’ worth to limit the risk of needing to sell during a downturn.
To prevent your emergency savings from depleting overmuch during inflation, experts also recommend holding your emergency stash in a high-yield account. Contrarywise, you should avoid illiquid or risky investments that jeopardize your savings, such as stocks or real estate.
Dissecting your investments
Investors and experts often debate how much cash is too much in a brokerage or investment account.
Many investors aim to keep about 5% of their holdings in cash (separate from their emergency savings). This provides a sturdy cushion to take advantage of buying opportunities or hedge against inflation. More cautious investors argue for more sizeable cash holdings – 10-20% – to guard against future downturns.
Here, too, age, finances and personal preferences play a role.
For example, younger investors who contribute steadily may hold far less cash, as they have more time to recover from volatility. On the other hand, near- or post-retirees may require larger cash reserves to avoid selling when the market crashes.
And for some investors, a larger nest egg simply provides the peace of mind they need to sleep through a market meltdown.
How to capitalize on King Cash during a recession
Your goals, preferences and point of view all impact whether you believe cash is king during a recession. To some investors, cash is a much-needed lifeline; for others, it’s simply a means to a discounted stock purchase end.
For investors who prefer larger cash holdings in good times or bad, Q.ai provides plenty of options.
To start, there’s our Cash Portfolio, which lets you preserve your cash at a modest interest rate. In the inverse, we offer a unique Inflation Kit to hedge against inflation and protect the value of your cash with non-cash holdings.
For our more risk-tolerant investors, we boast an enormous range of Investment Kits, each capitalizing on a different sector or angle in the market. To top it off, we even offer our AI-backed Portfolio Protection option to protect your gains, so you can afford to invest another day.
Download Q.ai today for access to AI-powered investment strategies. When you deposit $100, we’ll add an additional $50 to your account.
