It’s a question as old as financial markets: How safe should we play it? How much money should we hold in cash vs. invest in stocks, bonds, or other assets? All investments come with risk. Returns are never guaranteed and there’s always a chance you’ll come out with less than you started with. For this reason, people who are more risk-averse might be inclined to hold on to most of their extra cash. The thing is, there are also risks to not investing enough: You can miss opportunities to grow your wealth. Not to mention that money tends to lose value over time (thanks, inflation.) "One important thing to understand about investing is the tradeoff between risk and reward: You cannot have one without the other,” said Brian Walsh, a Certified Financial Planner® and SoFi’s Head of Advice & Planning. Unfortunately, there is no magic ratio of cash vs. investments that fits for every situation. It’s a balancing act, and depends on many factors, including your appetite for risk, your current financial situation, your goals, and how long you’re planning to be invested. Here are some key things to consider when deciding how to allocate your money.

First thing’s first: How much cash do you need?

When we say holding cash, we’re not just talking about the bills stuffed in your wallet. We’re talking about everything you have in your checking, savings, and money market accounts, plus what are known as cash equivalents — typically defined as assets that mature in under 90 days and are readily convertible to known cash values (think: short-term CDs and Treasury bills). Financial advisors generally recommend having enough liquid cash saved to cover three to six months’ worth of living expenses. (If you generally spend $5,000/month, you would have between $15,000 and $30,000 to fall back on in case of a job loss, major medical expense, or other financial setback.) And keeping that money in an interest-bearing vehicle like a high-yield savings account can help you keep up with inflation (SoFi’s has an APY of up to 3.8%). If you don’t have a financial buffer — or if you’re stretching just to pay for your necessities each month — you may not have the money to spare for investing right now. But if you have enough to invest, how much should you invest? Some advisors recommend keeping between 2% and 10% of your portfolio in cash and equivalents. Another rule of thumb is the rule of 110, where you subtract your age from 110 to gauge how much of your money you should keep in stocks. So if you are 35, you’d keep 75% of your investible assets in stocks — the rest could be in bonds or cash. (Depending on your risk tolerance, the rule can be varied with a starting number of 120 or 100). Of course, it may make sense to hold higher levels of cash under certain circumstances. Maybe your income isn’t steady or you’re planning a big purchase in the next few years (like a house or college tuition.)

Why invest at all? Let’s talk about opportunity cost

When you give up a potential benefit by choosing one option over another, it’s known as opportunity cost. While holding on to all your cash can shield you from volatility, the opportunity cost is any upside you might get from investing it. People talk about the opportunity cost of not investing in the U.S. stock market because despite its ups and downs — especially in recent months — the benchmark S&P 500 index has trended up over time. The average annualized return is about 10% per year, or 6% to 7% after inflation (not accounting for fees, expenses, and taxes). Annual returns often vary widely, and the historical average is not a reliable indicator for a specific year, but long-term investing is based on the idea that you’re probably better off staying in the market. Of course, past performance is never a guarantee of future returns, and that’s all part of the risk-reward equation. “Stock market investing can be more appropriate for big goals in the distant future, such as saving for a child’s education or your own retirement,” said Walsh. “A longer time horizon not only gives your investments a chance to grow but a chance to ride out market downturns that may occur along the way.”

Determining your asset allocation: Factors to weigh

Risk Tolerance (and Capacity)

There are two facets of risk-taking: your willingness (tolerance,) and your ability (capacity.) Someone with enough savings to cover two years’ worth of living expenses may not want to invest any of it even if they’re a good candidate. Likewise, even if someone feels comfortable investing all their emergency savings, that doesn’t mean they should. When it comes to tolerance, research shows that women are inclined to be more risk-averse with their money than men, but when they do invest they tend to outperform men. The bottom line: In addition to tolerance, you should consider how much risk you are realistically able to accept.

Time Horizon

Your investment horizon — the length of time you plan to hold an investment before you need to sell it — is another factor to consider. If you plan to retire and cash out your 401(k) soon, you have a shorter investment time horizon and a lower risk capacity for the volatility of the market. In this scenario, you might adjust your portfolio to have a higher ratio of lower-risk holdings. On the other hand, if you’re not retiring for 30-plus years, you have a longer horizon and therefore better odds of weathering the ups-and-downs of the market. “Because higher-risk assets can go through periods of significant downside, they are generally only recommended for money that you won’t need for awhile,” said Walsh. "Time can either be your best friend or worst enemy. Make it your best friend by investing early so your money has more time to grow."

Financial Goals

A lot depends on where you are in your life, too. If you’re planning on making your first big college tuition payment soon or throwing a wedding, you might feel more comfortable keeping more of your money in cash to reduce the risk of losses. But if you’re saving to buy a house someday, you might get your down payment faster if you invest some of your money.

Economic Environment

There are also external factors to consider. For example, you might feel more comfortable holding higher levels of cash when interest rates are high because that’s when you can generally earn higher returns from things like a high-yield savings account or T-bonds. This shifts the opportunity cost, increasing the relative attractiveness of cash equivalents versus riskier assets like stocks. When interest rates are low, however, the opposite may be true. After the Fed slashed its benchmark rate to virtually zero in 2020, for instance, the interest you could earn on cash was negligible while stocks soared. The question of asset allocation can feel daunting, but considering how these different factors apply to you can help you feel more confident in your decisions. And it’s not a one-and-doner: You’ll want to reassess your mix of cash versus investments as your financial situation and goals shift.

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