Sitting in Cash May Not Be the Safe Haven You Think
I'm channeling my inner Joan Rivers: "Can we talk?"
Over the years, we've seen in our work for new clients that way too many hold way too much cash in their portfolio when they come to us. Why is that?
I can narrow the reasons for large cash balances to the following:
Busyness. Cash accumulates, awaiting the time when they can give their portfolio the proper attention.
No investment plan. One important reason to have an investment plan is that it becomes your guide for investing cash. Without a plan, there's a randomness to what you choose for investment each time cash accumulates. Often this results in nothing being done or, worse yet, investing in what currently works in the market.
Worry. They are worried about the markets and expect to buy at better prices sometime in the future.
Future expenses. They have an upcoming expenditure, and the cash is reserved to cover the cost.
In my opinion, the only reason you should hold cash is to cover a future expense, and then only if the expense is expected within the next few months. I believe cash should be invested because the cost of holding cash is substantial when measured over your investment horizon.
The best way to avoid accumulating cash is to put in place an investment plan that integrates your cash needs with targets for fixed income and stock investments. This plan will express your portfolio in terms of time, or when and how much you will need from your investments. Understanding time and your portfolio quantifies the types of investments you should buy, helping give you the confidence to keep investing.
I understand the temptation to let cash build after the stock market has had a strong move; it's always easy to see risk in stock prices. For instance, right now, one could easily be cautious about buying stocks, especially considering the tax talk out of Washington.
The problem with attempting this sort of market timing is that the risks do not translate into a falling market more often than not. Or, if the market does fall, the cash is not invested as new risks are identified.
Understanding time and your money becomes the guide to help you look through today's risks and see the larger picture. If the stock investments you make today with cash are unneeded for decades, you can have confidence that investing your cash today will still keep you on track with your plans.
There is a saying on Wall Street that cash is king, and that's true when markets are falling. Periods of market declines, however, are more often than not short-lived. Cash is certainly king when markets adjust, but to take advantage of having cash, you must buy when everyone else sells—not an easy thing to do.
On the contrary, in most markets, cash may actually be a drag on your returns, impeding your ability to reach your goals.
Let's take a look at some possible reasons cash works against you.
There has been a lot of talk about inflation over the last several months. The Federal Reserve is rightly making a big deal out of inflation, and so too is the market. But why?
Many years ago, it was thought that 0% inflation indicated the economy was healthy. That view centered on the idea that 0% inflation preserved the dollar's purchasing power and signified things were in balance.
Over the years, economists have come to change that view. They now see modest inflation (often defined as 2%/year) as healthier for the economy. Why is that? It has a lot to do with how they have seen monetary policy working against economic growth. The lesson of the depression was that the central bank impeded recovery by being too focused on inflation. What seems to be the lesson is that targeting 0% inflation is too costly; it requires a more restrictive monetary policy than is warranted.
Economists have concluded that a little bit of inflation is not harmful so long as it is predictable and does not spike. With a 2% inflation goal, the Federal Reserve can allow the economy to grow without needing to step in and slow things down.
This thinking was codified into the Fed's mandate a few decades back when Congress passed legislation expanding the Fed's targets to include price stability and employment. It no longer was all about prices.
For individual investors, even 2% inflation can do real damage over time. Cash balances experience deterioration in absolute value when there is any inflation in the economy.
Thus a $10 item today will cost $10.20 a year from now; in 10-years, it'll cost $12.19. To keep up with 2% inflation, you'll need to earn over 20% on your money over 10-years. To do that, your cash must be invested.
Another concern for those holding cash is the value of the U.S. dollar. The U.S. Dollar Index is a valuation of the dollar against a basket of securities. According to Yahoo Finance, over the last year, the Dollar Index has declined from 97.32 on June 29, 2020, to 92.06 on June 29, 2021.
For travelers, the effect is immediate. They will find their money buying far less when they go overseas. However, in this interconnected world, the impact of a falling dollar affects all Americans. Goods imported into the U.S. become more expensive and goods exported from the U.S. command a lower value.
For those worried that the dollar may be in decline, their inclination may be to hold cash due to the uncertainty. In fact, cash can be the worst "investment" for them; they need investments that can earn a return to help offset the decline in the dollar's value.
Today, those sitting on cash are likely doing so in anticipation of some sort of black swan event, a market collapse of epic proportion. It's a bit of a learned response to some recent periods when the market was strong. But when you understand how markets and time work together, it is easy to show that it is the wrong response.
In my opinion, it does not make sense to hold cash today.
We believe the key to it all is proper planning. That planning should include a detailed schedule of expenditures in the near- and long-term future, to the best of your ability. That view will allow you to see how your money should be invested and keep you on track. It'll give you the confidence to invest your cash as it becomes available and avoid the pitfalls of accumulating unneeded cash balances.
Please give me a call to discuss how we at Nicollet Investment Management can help you navigate how to deploy your cash today.