As part of our due diligence process, we regularly check money market accounts to determine the best option for our client’s cash. There are many difference types of money market accounts; federal municipal, PA municipal, and FDIC insured accounts are just some of the examples. Today almost all the rates for these investments are near .01%.
For investors, risk can be defined in many different ways. Risk can mean the loss of capital; not earning a rate of return necessary to meet your goals or not maintaining purchasing power. Depending on the way you define risk, the money in you hold in cash can truly be the most risky asset in your portfolio.
The Bureau of Labor Statistics says inflation, as measured by the CPI index (less food and energy) was 2.1% ending July 2012. The average annual inflation rate starting in 1913 and as of August 13, 2012 was 3.24% according to inflationdata.com. There are even items that are not accounted for in inflation, and technology often tempts us into an ever higher standard of living. Remember when you did not pay for TV service? Then everyone wanted basic cable as the standard, but now people prefer premium channels, high-definition channels and more. These alternate choices are not counted in inflation. As another example, while it’s not standard, many people are now opting for a navigation system, wireless communication system or perhaps a back-up camera for their cars. If you really look at what cash really returns, you might conclude that having your money in cash is actually losing you money!
Using cash as a strategy to time the market can also wreak havoc on your investment returns. Goldman Sachs Asset Management conducted a study which showed that the rate of return for investors who missed the ten best days in the S&P 500 was 3.67% less than investors who stayed fully invested over the period 1992 through 2011. Stocks will continue to be volatile in the short run, but historically they give you the opportunity to outpace inflation in the long run. See Rick Rodgers ‘article about embracing volatility from his “It’s Your Money” column.
While it is important to have a cash reserve for emergencies, an investor should think very carefully about the role of cash and its real impact on his/her portfolio.