Investing 101: Why Cash Is More Risky Than You Think

money treeMany investors with high cash holdings are “underinvested” in stocks, bonds and other long-term investments.

If you’re sitting on the sidelines, now’s the time to make a plan to put your money to work for you. The prudent solution is to gradually move money into a diversified portfolio. With longevity and inflation risks on the horizon, the simple fact is that cash can’t get you where you need to go.

“People don’t realize that cash is risky,” says David Blanchett, the retirement research chief at Morningstar Investment Management. “You think of cash as being a safe investment, but if cash is yielding nothing and inflation is 2.5% to 3%, you’re losing money every year; and it’s a guaranteed loss over time.”

If you look closely at how cash has performed in your portfolio over the last ten years (from 2004 to 2013) you would be very surprised to find it has ranked almost dead last in preserving and growing your purchasing power.

In a comparison of the ten major asset classes, ranging from the S&P 500, to bonds, REITs, and emerging market stocks, cash ranked second to last over the recent ten-year period (only commodities did worse). That’s hard to believe, given that we’ve just come through the biggest economic meltdown since the Great Depression. Even in that brutal economic landscape, an investor would have done better putting her money in emerging market stocks, REITs, the S&P 500, bonds, balanced funds, or virtually anything else, than parking her money in cash and sitting it out.

So if “safety” is redefined as the asset’s ability to preserve your purchasing power in the face of inflation, cash would be almost the last asset you should ever turn to.

The Takeaway: Investors need a more nuanced view of what assets are “safe” and which are “risky.” Cash may be “safe” over the very short-term time horizon since its value doesn’t move up and down. But over the longer-term (for example, over your retirement time horizon), cash becomes almost the riskiest asset of all, losing ground daily to inflation and increasing the risk of running out of money before you run out of life.

 

About Mari Adam

Mari Adam, Certified Financial Planner™ and President of Adam Financial Associates Inc, has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!

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