If you see storm clouds hovering ominously over the markets, it’s only natural to seek a safe harbor.
Right now, many people do fear that turbulent times are ahead, whether because of the so-called Fiscal Cliff, because of Europe’s drag on the world economy or other factors. And many of those folks, wanting to protect their assets, have sought out cash—which they see as a safe harbor.
Leaving aside the prospects for the economy and markets for the moment, let’s look at the practice of “parking” your savings in cash. Cash—or “cash equivalents” such as money-market funds—may not be as safe as you think. Over the long term, a large cash position will gradually but surely erode your purchasing power.
Example: At an inflation rate of 2% (which is around the current rate) your $100,000 in cash will have a real buying power of just $81,707 a decade from now. And 2% inflation, by the way, is low by historical standards; many experts believe the rate will rise in the coming years.
The erosive power of inflation is especially worrisome if you’re retired or approaching retirement. If your goal is to convert your savings into a comfortable income stream for 20 or 30 years, and you aren’t receiving new income from work, then steering clear of inflation damage should be a top priority.
Look at it this way: Being in cash isn’t a way to defer your investment decisions—it is an investment decision. By investing in stocks and bonds, it’s true that you have a chance to make money as well as lose it. But in cash, you’re sure to lose money over time.
Right now, you’ll even lose money if you’re in cash-like investments such as money market funds and CDs. The best interest rates on both of those investments is only around 1% right now–about half of the current inflation rate.
Again, that slow leak of purchasing power can really impact your quality of life in retirement, and in some cases can even play a role in delaying your retirement.
A better alternative is to invest in a properly diversified portfolio of investments that, over time, provides you with the opportunity to reap solid gains while minimizing risk from market downswings.
Yes, the water may be choppy at times. But a portfolio that’s built taking your goals and your risk tolerance into account is like a sturdy ship. In stormy weather or clear weather, being on the sea in that well-built craft gives you the best chance to reach your goals.