One of the data points I periodically look at is the stock, bond, and cash allocations of individual investors as measured by the American Association of Individual Investors (AAII) monthly survey. I like to review what individual investors are thinking and doing compared to institutional investors. We have highlighted these differences in this blog in the past and will continue to do so. For this post, let’s focus on the cash level of individual investors as measured by the most recent survey of the AAII (Chart 1), which is currently 16%. Interestingly, this is lower than the five-year average of 17.8% (Chart 2).
Chart 1: Stock, Bond & Cash Allocation of AAII investors, July 2025
Source: American Association of Individual Investors
Chart 2: Five-Year Cash Level of AAII Investors as of July 2025
Source: American Association of Individual Investors
Why do investors keep so much cash? To be clear, there are sound reasons for holding higher levels of cash. These can range from low risk tolerance to an upcoming large purchase for cash, or saving for a particular future event. With cash yielding between 3% and 4%, this is not necessarily a bad option. However, most other asset classes have higher expected long-term returns than cash. In the Sunpointe model portfolio, our default cash level is 1%.
The reason for this high cash level may be explained by mental accounting bias, a behavioral bias in which people treat one sum of money differently from another equal-sized sum based on which mental account they assign each pool of money. In this case, people don’t look at their overall cash level but rather hold cash across all their accounts. Investing this way contradicts rational economic thought because money is inherently exchangeable.
Mental accounts are based on arbitrary classifications, such as the source of the money (e.g., salary, bonus, inheritance, gambling) or the planned use of the money (e.g., leisure, necessities). According to traditional finance theory, investors should consider portfolios holistically in a risk/return context. The long-term risk of this behavior is reducing expected returns on the overall portfolio because of cash drag. Chart 3 below illustrates an example of mental accounting bias in terms of holding too much cash across several family accounts.
Chart 3: Mental Accounting Bias Example 
Understanding these behavioral patterns allows us to identify specific strategic responses that can help investors optimize their portfolios. Given the prevalence and impact of mental accounting bias, what practical steps can investors take to address this issue?
Here are Sunpointe’s Strategic Investment Considerations:
Behavioral Finance and Mental Accounting Bias
- Observation: Investors may keep excess cash because they mentally separate it from their “investment” accounts — perhaps labeling it as emergency funds, “dry powder,” or “safe money.”
- Implication: This can result in inefficient portfolios where cash holdings earn low returns and fail to offset risks in other asset classes. Mental accounting also leads to missed opportunities for diversification and higher expected returns.
- Action point: Reframing cash as part of the overall risk/return strategy can help reallocate excess idle funds into more productive assets. Understanding these behavioral patterns allows us to identify specific strategic responses that can help investors optimize their portfolios.
Risk-Return Tradeoff Distortion
- Observation: With cash yielding modest returns (even if short-term rates are higher now than in the past), holding 16% cash reduces the long-term compounding potential of the portfolio.
- Implication: Over the long term, high cash allocations can create a significant opportunity cost — particularly if inflation erodes real purchasing power.
- Action point: Stress-test portfolios under inflation scenarios to show how prolonged high cash holdings can reduce real wealth over time.
Market Timing and “Dry Powder” Misuse
- Observation: Some investors may hold excess cash believing they will deploy it during “the right opportunity,” but behavioral research shows that timing the market is extremely difficult.
- Implication: This often leads to staying in cash too long, missing rebounds, and underperforming buy-and-hold strategies.
- Action point: A systematic, rules-based approach (e.g., dollar-cost averaging into equities) can help avoid paralysis and reduce timing errors.
Summary
The latest AAII survey shows individual investors holding 16% of their portfolios in cash, well above the levels in our model portfolios and yet below the five-year AAII average of nearly 18%. This elevated cash position may be driven by mental accounting bias, where investors treat cash as separate “safe” money, leading to inefficient portfolios, missed diversification, and long-term opportunity costs. Historically, such high cash levels have sometimes signaled excessive caution, creating potential contrarian opportunities for disciplined, fully invested strategies.
If you would like to discuss how these insights relate to your specific financial situation and investment strategy, please contact your Sunpointe advisor. We welcome the opportunity to explain how we help clients navigate these investment challenges.
