3 Motives for Holding Cash

1. The transactions motive. "The need of cash for the current transaction
of personal and business exchanges."

Keynes disaggregates this motive into two sub-classes, the income motive and the
business motive, but the rationale is pretty much the same for both: often there is a
considerable time interval between when cash is needed and when it is available,
such as when there are delays in its disbursement, as in the case of wages for you
maybe one day individuals (income motive) and revenues or payments for
businesses (business motive). If the need to spend cash is immediate (as is almost
always the case) and the delay is considerable, sufficient cash must be readily
available to bridge the gap.

2. The precautionary motive. "The desire for security as to the future

cash equivalent of a certain proportion of total resources."

This is where the "emergency" in "emergency fund" comes from: we need to hold a
certain amount of cash for unforeseeable and unexpected expenses that are not (or
cannot be) covered by standard risk management instruments like insurance. In my
opinion, this is the most important reason for storing cash in liquid and safe assets,
as I've seen real assets unnecessarily liquidated (at steep discounts) and small
fortunes get wiped out in a small amount of time because of catastrophic financial
emergencies.

Keynes points out that the strength of the above motives partly depends on the
cheapness and

the reliability of methods of obtaining cash, when it is required, by some form of

temporary borrowing, since holding idle cash won't be necessary if it can be
obtained without difficulty at the moment when it is actually required. In real life,
though, since these sources of "temporary borrowing" can smell desperate need
from a mile away and raise interest to unreasonable levels accordingly, it often
makes more sense to just hold a substantial amount of cash and just pay whatever
opportunity costs you incur.

3. The speculative motive. "The object of securing profit from knowing

better than the market what the future will bring forth."

In general, the importance of the first two motives is driven by the usual activity of
the economic system; the speculative motive, on the other hand, is more a result of
extraordinary economic circumstances like financial crises and bubble bursts that
result in irrationally depressed asset prices and consequently, opportunities to earn
abnormally high returns. Investors who had ample cash reserves during the 2008
financial crisis, and even at the height of the recent (and still on going) middle east
unrest or the Japan disaster, could have taken advantage of depressed stock prices
and made a considerable killing a reasonable amount of time after, provided they
are able to keep their heads amid an environment of mob-market panic selling. If we
look at how markets have recovered from these lows, it's easy to see how the cost of
not having enough cash to take advantage of these circumstances could be very
significant.

To end, these motives show us that there are tradeoffs involved in holding cash:
while we lose the opportunity to earn (possibly) high returns from investing in risky
assets like stocks and bonds, maintaining cash reserves also provides valuable
benefits by protecting us from unpredictable, risky situations and giving us the
capability to exploit rare opportunities to invest at a bargain. Hopefully, with these
points it would be easier for investors to understand why it is important to first
build an emergency fund before one invests in high-risk, high-return assets.