What follows is the fourth of seven to-the-point articles highlighting poor investments you should avoid.
4 of 7: Cash
Cash is today’s loser.
If January of this year, pre-COVID-19, Bankrate published a poll in which only 41% of Americans said they could cover a $1,000 emergency such as car repairs or medical bills. Where did survey respondents say would they go if they met such an emergency? The top two answers were to their family with their head down and hand out, or to their favorite credit card, likely boasting an interest rate somewhere between 15 and 25%. Who said rates were low?
Each year, the Federal Reserve issues a Report on the Economic Well-Being of U.S. Households and, year after year, they find that roughly 40% of U.S. households would have difficulty coping with a $400 unexpected expense. In our COVID-19 shutdown, that sounds scary.
So perhaps 40 to 70% of Americans need more cash on hand, with most of these needing significantly more because they have almost none. Embedded in this reality is an important and interesting discussion that invokes the wide-ranging topics of education, wages, economic equality, budget discipline or lack thereof. It is middle-of-the-plate personal finance material; it isn’t really an investment discussion. Ideally everyone should build a cash reserve to meet these small emergencies, and then they should go beyond this to build an adequate emergency fund, a level of funding best determined by deeper individualized analysis not suited to this short article chiefly on a topic other than how one would determine the textbook size of their emergency fund.
With those concessions about cash savings made, I return to an investing discussion and my thesis that cash is a poor investment. There are few sure bets in investing, but perhaps the most reliable is that cash is a consistent and significant loser over any substantial timeframe.
Will stocks go up or down over the next three years? Don’t know. Will crude oil go up or down over the next ten years? Don’t know. Will treasury bonds go up or down over the next five years? Don’t know. Will cash be less valuable in two years? Almost certainly. Will cash be less valuable in ten years? It’s the surest 10-year bet you could make if only you could find someone to take the other side.
In a CNBC article, famed investor and billionaire Ray Dalio said saving in cash is “the worst thing you can do. Over a longer period of time, equities will have a higher return, bonds will have a higher return, real estate will have a higher return than cash. People with great ideas create productivity and get paid for it,” Dalio says. “It is better to invest in productivity than to not invest in productivity, because otherwise your money will lose buying power.”
You can play with the BLS’ Inflation Calculator yourself and see just how impactful inflation is over time. Let me provide a 50-year snapshot to illustrate what this looks like in dollar terms. $100,000 of purchasing power in 1970 now requires $665,945!
If you were in all cash in March of 2020, when the Dow was dropping 1000 and 2000 points a day, you felt good. You felt smart. But let’s be honest, the only people that were in all cash in March had been in cash for the last ten years and had therefore sat out a stock market that turned every dollar into four. And these last ten years are a pretty good microcosm of the last 100 years. The best investment returns follow the recession or economic shock. When things are darkest and you look out your window to see your neighbor simultaneously hanging out the white flag and tucking his tail to run, at that very point, the bottom is in. From that moment of utter capitulation, things go one direction – up. In fact, perhaps the best way to understand the action of the stock market over the last century is an oft-called-upon adage that the market “climbs a wall of worry.”
The injury cash deals your investment returns might be likened to friendly fire. It won’t be particularly painful on any one day. There is no crash in which your investment drops 5% in a day, not even in a month. Nothing is scary about this invisible operation in which your wealth is ever so slowly inflated away.
But what else has lost value 63 of the last 64 years? In a world of uncertainty, the surest bet is that the value of a paper dollar will continually, consistently erode!