Uninvested money is money that sits in an investor's account and has not yet been allocated to any investment. Cash drag, or the idle money effect, is a situation in which money sitting idle fails, over a longer period, to earn the potential return it could have obtained if it had been invested. For this reason, cash drag does not appear on an account statement as a direct loss, but it can have a specifically calculable opportunity cost, in other words unearned profit.

In brief:

• Uninvested money in an investor's account can create so-called cash drag, or the idle money effect, namely a missed opportunity to obtain a predictable return.

• In fixed-return investments, this effect can be calculated fairly precisely, because the amount, the rate and the time during which the money is not invested are all known.

• Idle money most often arises after a deposit into an investment account, after the end of an investment term, or while waiting for the right moment to invest.

• It would also not be right to invest absolutely all of your money down to the last euro. There must always be a freely available reserve for unforeseen expenses and other financial goals.

• Automated reinvestment and flexible investment solutions can help reduce the time during which money simply sits in an account.

What is cash drag and how do you calculate it?

The essence of cash drag is simple: the longer money sits idle, the longer it goes without the return that would have been available if it had been invested.

How much does money lying in an account cost? In the case of fixed-return investments, this is not difficult to calculate. For example, if the terms of an investment provide for a 6% annual return, 10,000 euros that go uninvested for 30 days means approximately 49 euros of unearned interest for this period.

10,000 x 6% x 30 / 365 ≈ 49 euros

All calculations mentioned in the article are illustrative, presented as gross results and do not take taxes into account. The actual result will depend on the terms of the specific investment.

This is not a loss in the direct sense; the balance in your account does not decrease by this amount. But that is the extent of the unearned profit that arose because the money was not invested during that particular period.

When does uninvested money most often sit idle?

Uninvested money most often accumulates in three cases.

• After a deposit into an investment account.

• After the end of an investment term.

• While waiting for a suitable moment for the next decision.

What happens after a deposit, before the first decision?

The first cash drag situation can arise immediately after money is transferred to an investment account. The money is available, but the investor has not yet decided where to allocate it.

Let us assume that there are 10,000 euros in the account and making a decision takes 30 days. At a fixed 6% annual return, approximately 49 euros could have been earned during this time.

The longer the decision is delayed, the greater the opportunity cost becomes.

What happens after the end of the term?

The second frequently observed moment is the end of an investment term. When the principal and accrued interest are received, the money can end up in the account while the investor chooses the next investment.

For example, if 10,000 euros remain uninvested for 60 days after the end of the term, at a 6% annual rate approximately 99 euros go unearned during this time.

Automatic reinvestment could be a very useful option here. In this case, the money is reinvested and continues to earn even while the investor has not yet made their next decision. Read more about how the rhythm of an investment's money affects the funds available in the article on cash flow in investments.

What does it cost to wait for the right moment?

The third situation is the most psychologically interesting one, because the investor does not invest the money as they are waiting for a more suitable moment.

In fixed-return investments, such waiting rarely provides a noticeable advantage, because the return is set in advance and usually does not depend on market fluctuations.

If 10,000 euros remain uninvested for 90 days, at a 6% annual rate the calculable unearned return would be approximately 148 euros.

Waiting is one of the most common mistakes in fixed-return investments. Read about the others in the article on the most common investing mistakes.

How long may money remain uninvested?

It is not necessary to eliminate idle money entirely, and it would not even be sensible. Free money in an account is needed for everyday needs, unforeseen expenses or near-term financial goals.

So instead of trying to achieve a zero balance in your account, consider realistically what amount of money genuinely will not be needed in the near future, and make sure it does not remain uninvested for longer than necessary.

How can you reduce cash drag?

If the money in question really is intended for investments, the essence of the solution is quite simple: reduce the time between receiving the money and investing it again.

One option is automatic reinvestment, which reduces the need to make a new decision manually after the end of each term. On the TWINO platform, this option is offered by investments in loan-backed securities.

The second option would be to use an investment product that does not have a traditional fixed end date. This means that the money is in an investment and continues to earn even while the investor is still thinking about where to allocate it in the longer term.

For example, TWINO FLEXI is designed as a flexible solution which, in accordance with the product terms, offers a fixed 6% annual return and the possibility to request a withdrawal of funds. Interest is accrued every day.

It is also important to remember that FLEXI is not a bank deposit and is not covered by the state deposit guarantee. The investment is exposed to risks, including credit risk and liquidity risk.

You will also find more information about the options for investing spare funds in the article on where to park idle cash in Europe.

To better understand how TWINO’s investment solutions work and what risks are associated with them, we invite you to review the FLEXI product page and product documentation.

Email: [email protected]
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This material is for informational purposes and is not individual investment advice.