In recent weeks, there have been people risking their wealth on speculative memes or taking their chances on cryptocurrencies. Then there have been others who have been taking on a different kind of risk altogether – the risk of not doing anything.
They wonder: Are we in a bubble? Are prices too high? Where is the safest place to park my money?
Because they are unable to answer these questions, they are choosing to leave the hard-earned money in cash, or put it in an investment that resembles cash, like a money market fund, certificate of deposit (CD) – or worse, a savings account.
In January, money market fund assets reached $4.3 Trillion, more than any point in history. The pandemic has likely magnified this, as consumers have benefited from fiscal stimulus and are spending less while staying at home.
But, playing it safe has its own risks.
Why is cash a problem? The math alone should convince you, but we’ll provide it here anyway.
As you might know, the Federal Reserve has set rates at historic lows, which reflects rates in money market funds (0.09%, as of 12/31/20)*. Never mind that a near 0% return on any investment would be less than ideal, but it looks increasingly likely for quite some time.
Some investors love their “guarantees” on cash. Right now, holders of cash are guaranteed one thing: to lose money after inflation. If you have a long time horizon, simply putting the money to work somewhere could lead to a better result than doing nothing or holding cash.
There are legitimate reasons to hold cash in a portfolio. But almost all of those reasons boil down to having flexibility when putting cash to work in the short term (like an upcoming college bill). Particularly if this is your explicit strategy, then holding cash for the short term makes sense.
But most investors may be holding cash because they are nervous, or want to be “conservative” in their investment approach. Their cash isn’t really a part of their portfolio – they are simply not including it as part of their investments. But, most investors can’t afford to sit on the sidelines. It is better to understand your concerns and address them with precision.
At the very least, investors ought to consider alternative approaches such as… short-duration bonds, convertible bonds, or high yield which can potentially yield more than the close-to-zero returns. And if you are concerned about inflation, stocks and commodities work well.
The bottom line
Investors who are sitting on cash might subscribe to the phrase “a bird in the hand is worth two in the bush.” But as soon as you extend the analogy, it becomes quite bizarre – and wrong.
Because in this analogy, you depend on birds for financial security, and that one measly bird is disintegrating in your hand.
Please reach out if you have any questions.