Cash Is Not King
Recently I’ve spoken with a number of people who have underestimated the risks of having too much in cash. Consequently, I wanted to share with you why cash isn’t necessarily king.
But first, let’s talk about why cash can be so appealing. The first reason people love cash is you have immediate access to it (in financial speak we call this liquidity). The second reason we love cash is it doesn’t go down in value (in financial speak we call this preservation of principle). A third reason, some may cite, is if the bank or credit union were to fail your cash is insured up to $250,000 per registration thanks to the FDIC or NCUA. Definitely something the proverbial stuffed mattress does not provide!
While the reasons above may seem to provide peace of mind, the reasons below should make you feel less comfortable about having too much in cash.
The first reason cash is not king is that the rate of return on cash is the worst. Literally! Historically it is the worst performing asset class. Not the second worst, not the third worst, but the worst.
Secondly, the inherent value of cash decreases over time because of inflation. This is the most concerning reason of all why cash is not king. As a reminder inflation is the slight increase in prices of goods and services over time. Gas, Milk, chocolate bars, surf boards, cars, etc have all increased in price since we were kids. Over the last 50 years the average price of goods and services increased 3.22% each year.
* https://inflationdata.com/Inflation/Inflation_Rate/Long_Term_Inflation.asp
That may not seem like a lot but let’s run some numbers to see the impact inflation has on the buying power of $10,000. After just one year it would have the buying power of $9,678 in today’s dollars. Imagine if your bank told you it lost $322 of your deposit? You’d be ticked, but that’s exactly what inflation essentially does. It gets worse with time. After 3 years it has the buying power of $9,064 dollars, and in 5 years it has the buying power of only $8,490! Note that after just 5 years your cash has “lost” over 15% of its buying power! That’s why I call inflation the silent thief.
“You can be young without money, but you can’t be old without it.”
So, what should you do instead with the cash? As I often tell clients, that depends on your goals. We always consider three major factors which I call the three “T’s”…Time, Tolerance, and Taxes; all of which are related to one another.
In the interest of not making this blog any longer, I’ll only briefly describe them.
Time
The amount of time you have before you need the invested cash will determine what are the best options. If you have more time, you have more options. We will want to consider options that provide you an increase in the form of either dividends, interest, capital gains, or a combination thereof.
Tolerance
This is simply a measure of how comfortable you are with the fluctuations in the value of your invested cash. As you have more time, usually you can tolerate shorter term fluctuations for longer term growth. However, there are options that can provide opportunities for growth while the risks can be mitigated.
Taxes
There are some types of income that are better than other types of income given a person’s specific tax situation. Municipal bond interest for high income individuals would be an example.
Conclusion
Having too much in cash can cause a significant drag on your net worth over time. The factors we consider are when you will need the money (time), how comfortable you are with fluctuations in the value (tolerance), and what impact it will have on your income (taxes).
If you feel you have too much in cash, or have questions about this email or any finance question for that matter, feel free to reach out!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including loss of principal. No strategy assures success or protects against loss.
