“Where am I going to put all the extra cash?” This question often gets posed to me when a client or prospect sells an asset like real estate or after a sale of a particular investment for reallocation purposes. And it’s especially challenging to answer when the questioner has a very conservative risk tolerance.
From the outset, one must realize that this is a #FirstWorldProblems red alert. It’s easy to just skate right by that reality, but we need to remember that it’s a blessing to have such “problems”.
Nevertheless, for those cautious among us, sizable amounts of cash become a conundrum because deciding whether to invest or not feels so perilous. There is the fear of investment risk in the stock market that causes volatility or the concern over interest rate risk in the bond market that can cause bond prices to fall when interest rates rise. All too often though conservative investors can treat keeping cash on the sidelines for the long-term as the risk-free decision.
As the above chart indicates1, plunking money in a savings account over and above your standard emergency fund allocations have several negatives. First, it hardly pays anything. $100,000 is going to yield around $80 of interest in a savings account. The income of the 1990s and early 2000s feel like ancient history. (Don’t even bring up the glory days of the 1980s and double digit returns within Certificates of Deposit.)
Second, inflation eats that income up quickly. The last time one could break even on inflation in a savings account was in 2006 and that was short-lived. If current inflation costs $4,453 and your $100,000 is only receiving $80 of income, your money is not just “sitting” in cash--it’s being slowly consumed by the parasite of inflation. There is an old saying that “Cash is King”. If it is, then inflation is a much more formidable rebel in the kingdom of money than it used to be.
As always, there are reasons for keeping cash, the question is for how long and how much? This is where financial advice comes in. It’s bears repeating: cash is not risk-free. If you think so, stop it. Inflation risk is real.
Please don’t misunderstand. This does not mean, that you should suddenly raise your risk tolerance by investing your cash in the stock market or an individual bond or a real estate investment, but it does mean that you may need to redefine your view of risk and think through your investment options.