Sitting on Cash Could Cost You a Lot of Money
Americans who hold a large percentage of their savings in cash, bank savings accounts, and certificates risk missing out on the potential for sizable gains in the markets.
Reviewing the past eleven rate cycles reveals that, for the last three years, cash-holding grew by 1 percent to 3 percent. If you build a portfolio entirely out of bonds, investing in different types over time, historically this would generate a 5.33 percent average return. This represents the return on a managed portfolio that combines interest and market returns. In comparison, the S&P 500 averaged 26.13 percent.
In simpler terms, an investment of $10,000 in a (well-performing) savings account would yield $612.08 at a 2 percent rate of return. While an investment portfolio tied to the S&P500 would have picked up an extra $10,065.74.
That’s a difference of $9,453.66.
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But what about inflation’s effect on cash?
One of the downsides of holding cash is that the buying power of your money slowly deteriorates due to inflation.
The current 10-year Treasury rate as of Dec. 5, 2023, was 4.18 percent. Barely staying about the annual US inflation rate was 3.2 percent for the 12 months ended October 2023.
This doesn’t mean that investment fared any better. It’s all subject to inflation. However, investing has some upside since it can offer greater returns. A lump-sum investment (of $10,000) beat inflation during the last three years for an inflation-adjusted return of about 8.85% cumulatively, or 3.23% per year.
This means that the real returns on $10,000 adjusted for inflation are closer to $2,896.90. A 71 percent reduction in purchasing power over the last three years. But you are still left holding the balance of $12,897. Not entirely bad for a one-time investment.
A bank savings account at 0.01 percent would have a return of $3. While the purchasing power of the $10,000 would have eroded to $7,102. Not a great play.
So How Much Should I Invest in Cash vs Stocks?
In addition to your risk profile and the returns you would like to net 2024’s market conditions can have massive financial implications.
In periods of economic growth and low-interest rates, stock prices generally climb. The amount you can earn on cash investments will remain limited (i.e. 2020).
Inversely, when interest rates increase and the prospects for economic growth become less certain (2022), savings accounts and cash equivalents become more attractive. This is why you saw all those Treasury I-Bonds articles.
However, it’s more likely that 2024 will perform on par with 2023. Those who are rushing to cash can miss out on the expected 8-12 percent market return.
We are going for the Hardest Soft Landing Ever!
Strategists expect the US economy to slow while avoiding a true recession. The lower likelihood of a painful economic downturn should irk the Bear-market doomers and bode well for your investment portfolio. The election cycle will likely add some heartburn.
In the end, hoarding cash out of fear comes with an opportunity cost. By sitting in cash, investors may miss out on the potential upside stocks could see in a soft landing. While bonds can offer financial protection in case of a recession, you are still in the crosshairs of inflation.
Overall, it will come down to how you want to play this game. When you are younger, it’s typically better to take the risk since you have more time to make it up on the back end.
The name of the game is “Buy and #Hold” with a dash of cash flow management.
Years from now people will look back and say prices were cheap. And, if you invest correctly throughout your lifetime, you can still become a millionaire (inflation or not). You need to have a firm understanding of how assets perform during the business cycle. Or at least, create a sound financial plan.
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