5 Key Points
- High cash yields are tempting but can be short-sighted: While a 5% return on cash savings might seem attractive, it often leads to missing out on long-term growth opportunities offered by the stock market.
- Inflation erodes purchasing power: Cash investments rarely keep pace with inflation, which can silently diminish your wealth over time, reducing the real value of your savings.
- Dollar-Cost Averaging (DCA) offers a solution: For those hesitant to invest a lump sum in a volatile market, DCA allows gradual market entry, mitigating timing risks while ensuring long-term growth.
- Equities as a hedge against inflation: While cash feels safe in the short term, investing in equities provides a better opportunity for your portfolio to grow and outpace inflation over time.
- Stay committed to long-term goals: Market trends fluctuate, but sticking to a long-term investment philosophy will help you weather market volatility and achieve sustained growth.
Don't Let High Interest Rates Tempt You to Sit on Cash: A Long-Term Perspective
In today's economic climate, where interest rates on cash and cash-like investments are reaching levels unseen in years, many investors find themselves drawn to the allure of seemingly "guaranteed" returns. It's understandable. The comfort of a 5% yield on your savings account can be hard to resist, especially when the stock market seems volatile and perched at all-time highs.
However, as a financial advisor, I've noticed a growing reluctance among clients to invest in equities. This fear of missing out on safe returns is causing them to park their money in cash, missing out on the long-term growth potential that the stock market offers.
Don't let short-term gains derail your long-term vision. If you've been tempted to shift your investment philosophy due to current interest rates, it's time to create a plan to realign with your goals.
The Allure of High-Yield Cash: A Double-Edged Sword
In recent months, I've observed a growing reluctance among clients to transition their cash holdings into the stock market. This hesitation is certainly understandable. Interest rates have climbed to levels not witnessed in years, and cash products like money market funds are now offering enticing returns of 5% or even higher. This has sparked numerous conversations with clients who essentially pose the same question: “Why should I subject my investments to the inherent risks of the market when I can comfortably secure a solid, seemingly risk-free return by simply keeping my money in cash?” This line of questioning is often accompanied by concerns about the market currently hovering near all-time highs and the ever-present fear of an impending market crash.
These concerns are entirely valid and reflect a prudent approach to financial decision-making. However, it's important to recognize that focusing solely on the immediate allure of high cash yields can inadvertently obscure the potential long-term ramifications of such a strategy. While a 5% return might appear attractive in the present, it's crucial to adopt a broader perspective and evaluate how this approach aligns with your comprehensive investment philosophy and long-term financial aspirations.
My Concern for You: The Silent Erosion of Wealth
The most significant downside of keeping your money parked in cash is the insidious impact of inflation. Over time, inflation erodes the purchasing power of your money. While cash might feel like a safe haven in the short term, it rarely keeps up with inflation over the long haul, let alone beats it. The Federal Reserve targets an annual inflation rate of around 2%, but history has shown us that inflation often surges past this benchmark, especially during periods of economic instability.
The Data Speaks: Interest Rates vs. Inflation
You don't have to look back decades to see how interest rates have struggled to outpace inflation. The table below compares the 3-month Treasury bill rate (a good proxy for money market and savings account rates) to the Consumer Price Index (CPI), the most common measure of inflation in the U.S.
Let's imagine you invested $100,000 in cash in 2010, earning the prevailing short-term interest rates each year. By the end of 2023, your nominal balance would have grown, but when adjusted for inflation using the CPI data, the real value of your investment would likely be significantly lower. In real purchasing power, your initial $100,000 would only be worth $78,200!
This stark reality underscores a crucial point: while cash may feel safe, it doesn't provide the growth necessary to keep up with inflation and maintain your purchasing power over time. If your goal is to grow your wealth and achieve your long-term financial objectives, it's imperative to strategically allocate a portion of your investments to equities.
The Rising Cost of Living: Inflation in Action
Another tangible illustration of inflation's impact is the steady increase in the price of everyday goods. I explored this phenomenon in a previous blog post, using the rising cost of a six-pack of beer as a relatable example. The price of that six-pack has climbed significantly over the years, underscoring how inflation affects even the most routine expenses. You can read more about this here: https://www.purposebuiltfs.com/blog/the-best-hedge-against-inflation-a-guide-to-retirement-planning-through-beer
While the allure of high-yield cash investments is understandable, especially in times of market uncertainty, it's vital to remember that they might not offer the growth needed to achieve your long-term financial goals. By diversifying your portfolio and strategically allocating a portion of your investments to equities, you position yourself to not only keep pace with inflation but also potentially grow your wealth over time.
Dollar-Cost Averaging: A Path to the Market & Financial Sucess
One of the most effective strategies I use to help clients overcome their fear of investing is dollar-cost averaging (DCA). This approach involves gradually entering the stock market over time, which reduces the risks associated with market timing. Rather than making a lump-sum investment when markets might be at a high, dollar-cost averaging helps clients invest in smaller increments, spreading out their exposure to market volatility.
For instance, one recommendation I have made in the past to a client was to invest 25% of their available cash now, then invest the remaining funds in 25% chunks over the next nine months. This strategy allows clients to ease into the market and reduces the anxiety of investing a large sum all at once, particularly when they’re concerned about buying in at high market levels.
By adopting a DCA strategy, clients remain committed to their long-term investment philosophy while also mitigating the fear of entering a volatile or expensive market.
The Long-Term Value of Sticking to an Investment Philosophy
When you are tempted by short-term trends—like today’s high-interest rates on cash—the key is to remember your long-term objectives at the core of your investment plan. While it’s tempting to chase immediate gains or guaranteed returns, the reality is that these opportunities are often short-lived. Market trends fluctuate, and interest rates won’t stay high forever.
Staying true to a disciplined investment philosophy means remembering that investing is about the long game. Historically, the stock market has shown resilience and upward growth, even after downturns. Missing out on this potential by sitting in cash for too long can be detrimental to your long-term financial health.
The Bottom Line
Today's high cash yields might be tempting, but don't let them derail your long-term investment strategy. The risks of inflation, coupled with the historical underperformance of cash and bonds over time, highlight the importance of considering a move into equities to fuel long-term growth. Remember, the stock market has a proven track record of reaching new all-time highs, rewarding patient and disciplined investors.
If you're hesitant about making a substantial investment in equities all at once, strategies like dollar-cost averaging can offer a gradual and less intimidating way to enter the market. This allows you to participate in potential market growth without the added stress of trying to time the market perfectly.
If you're looking to stay on track with your investment strategy or want to explore ways to balance short-term needs with long-term goals, set up a meeting now or explore the wealth of resources available on the Purpose Built website. Remember, investing isn't about chasing short-term gains; it's about building a secure financial future.
Sources:
- https://www.macrotrends.net/2526/sp-500-historical-annual-returns
- https://www.federalreserve.gov/monetarypolicy/openmarket.htm
- https://www.usinflationcalculator.com/inflation/historical-inflation-rates/)
- https://fred.stlouisfed.org/series/DTB3
- https://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart
- https://www.usinflationcalculator.com/inflation/consumer-price-index-and-annual-percent-changes-from-1913-to-2008/
FAQ
Q: Why shouldn't I keep all my money in high-yield cash accounts?
A: While high-yield cash accounts may offer short-term stability, they typically don’t keep up with inflation in the long term. Over time, the purchasing power of your savings diminishes, making it harder to achieve your financial goals.
Q: What is Dollar-Cost Averaging (DCA), and how can it help me?
A: DCA is an investment strategy where you invest a fixed amount of money in the stock market at regular intervals. This helps reduce the risks associated with market volatility and avoids the pressure of trying to time the market.
Q: Isn't the stock market too risky with all-time highs?
A: Although the stock market experiences volatility, historically, it has delivered long-term growth. By investing steadily and diversifying your portfolio, you can minimize risk and position yourself for potential market gains.
Q: How does inflation impact my cash investments?
A: Inflation erodes the value of money over time. Even if you're earning a 5% return on your cash investments, inflation may reduce your purchasing power, leaving you with less real value.
Q: When is it better to invest in equities rather than sit in cash?
A: If your financial goals include long-term growth, investing in equities is crucial. Equities tend to outperform cash over time, helping you build wealth and keep pace with inflation.
About the Author
Sean Lovison, CPA, CFP®, is a flat fee-only financial planner based in Moorestown, New Jersey, serving clients virtually nationwide. After spending 14 years as a corporate chief financial officer (CFO), receiving and designing compensation plans, he decided to help others navigate their plans.
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