Having Access to Cash Increases Life Satisfaction

While cash is a drag on investment returns, especially in a low interest rate environment, there may be a reason to allocate as much as you think is necessary: happiness.

Traditional approaches to portfolio allocation recommend holding only enough cash to meet short-term spending needs. While cash is a drag on investment returns—especially in a low interest rate environment—there may be a reason to allocate as much as you think is necessary: happiness.

A study of a large United Kingdom bank’s customers by professors at the University of California, Riverside, and the University of Cambridge found having money is “associated with greater life satisfaction.” The researchers described the strength of the association between life satisfaction and cash as being comparable to the effect of total investments (which may include money market accounts) and being slightly greater than having no debt. Having “cash on hand” was found to be meaningfully above both investments and being debt-free in terms of its effect on financial well-being.

The researchers looked at logarithmic, meaning proportionate, increases in wealth. A 1-log increase, for example would be going from 1 British pound sterling to 10 pounds. A 3-log increase in the balance of checking and savings accounts, such as going from 1 pound to 1,000 pounds (“rags-to-sufficiency” instead of “rags-to-riches”), is associated with a 10% gain in life satisfaction. Additional increases revealed diminishing levels of improvement, with a 1-log increase of 1,000 pounds to 10,000 pounds causing life satisfaction to increase by just 3.5%. The researchers construed this finding as highlighting “the importance of holding a minimal financial buffer, but also the relative unimportance of having wealth above sufficiency levels.”

In discussing the study on his blog, Nerd’s Eye View, financial planner Michael Kitces opined that beyond the amount of cash held, where the cash is located matters too. “Holding the cash in an investment account may be still be sub-optimal,” wrote Kitces. He rationalized that the extent to which investment accounts, especially retirement accounts, are earmarked as future income, investors may not view the cash held within them as being available for current spending needs. To the extent this holds true, holding the cash in a checking or savings account at a bank or credit union may be as important as the allocation itself.

Sources: “How Your Bank Balance Buys Happiness: The Importance of ‘Cash on Hand’ to Life Satisfaction,” Peter Ruberton, Joe Gladstone, and Sonja Lyubomirsky; Emotion, Vol. 16, 2016; “Buying Happiness and Life Satisfaction with Greater Cash-on-Hand Reserves,” Michael Kitces, Nerd’s Eye View, April 26, 2017.