The Problem with Cash

An odd phenomenon has occurred over the last year and a half. If I had not seen and experienced it myself, I never would have believed it. Yet, despite a period of economic instability, higher than average job loss, and general uncertainty, Americans have managed to increase their holdings in one particular asset class. That’s right, I’m talking about cold, hard cash. In fact, the average American household went from saving just 7% of their disposable income in December of 2019 to a record high 33.7% in April of 2020[i]. That number came down to about 14% this past April, which is still twice the savings rate at the end of 2019.

???????????????The cause of this rise in savings has a few explanations. Some point to the lockdowns as a reason for families to stay home and not spend their discretionary income. Others point to the fear of losing a job and the desire to have a robust safety net. Yet another contributing factor is the stimulus checks and increased unemployment benefit. Whatever the reason, or combination of them, Americans are now faced with a peculiar problem: what do I do with all of this cash?

???????????????The instinct of many is to keep excess cash in their savings account. The perceived benefit of this strategy is the inherent “safety” that comes with keeping your money out of the market and in a bank account with FDIC protections. After all, why take the risk of investing in the market? Who knows when the pandemic with finally be declared defeated? What if the lockdowns start again and I lose my job? These are all valid concerns and should be taken seriously. However, it is also worth considering that a savings account has at least one glaring enemy that threatens to devalue your hard-earned dollars into oblivion. That enemy is inflation. Inflation is the brutal enemy of cash but until recently, it has acted more like a sleeping giant. Now, with the economy reopening and trillions of dollars’ worth of stimulus payments beginning to flood the market, that giant is finally waking up.

???????????????Since 2010, inflation has not breached 4% and, until recently, hit a high of 3.87% in September of 2011, which it had not since eclipsed. Thus far, in 2021, inflation has hit about 5.4% and does not show signs of stopping at the present, although Federal Reserve Chairman, Jerome Powell, is of the opinion that this is temporary[ii].

???????????????The bottom line for the average family is that, while cash is safe from market volatility, it has no defense against the devaluing effects of inflation. Think of it this way, the average savings account yields at most 0.06%. If inflation persists at 5.4%, that means your dollars will lose 5.34% of their buying power as prices rise and the economy responds. Of course, interest rates could very well go back down to last year’s many manageable 1.4% but even in that scenario it does not pay to have your money in cash in a savings account.

???????????????So what is the solution? Should you abandon cash altogether? Absolutely not! Despite the inflation numbers that we are seeing, I still stand by the old rule of keeping 3-6 months’ worth of expenses in cash as an emergency fund (although I would lean towards 6 months given the projected cost increases due to inflation). That said, what should you do with excess savings above and beyond and emergency fund in a savings account?

???????????????The answer to this question is a very personal one and there is no blanket recommendation for everyone. At Provisio Retirement Partners, we have faced this problem with many clients over the past year and the solution usually follows the same line of thought albeit customized to fit the client’s situation and risk tolerance. However, I will list a few ideas here for your general edification but before making any decisions, please consult your financial advisor.

Increase Retirement Plan Contributions

???????????????If you are young, healthy, and in your prime earning years, now could be a great time to juice up your retirement plan contributions and give your investment portfolio a boost. If you are in this stage of life, then your tolerance for risk is likely high given your long time horizon until retirement. If you already have your emergency fund covered, put those extra funds to work in the market! Remember, your contribution limits for 2021 are $6,000 into an IRA or Roth IRA and $19,500 into your 401(k) (before age 50). Take advantage of it if you can!

Short Duration Bond Funds

???????????????Let’s say that you are nearing retirement and want a solution for your excess cash that is better than the bank but without all of the volatility of the market. One idea for you would be to invest in a short duration bond fund. These funds are invested primarily in short term, government and corporate debt. Duration refers to a bond’s sensitivity to interest rate changes and a short duration bond is one that typically has low volatility and a time until maturity between 1 – 5 years. A short duration bond fund invests in many of these types of bonds and attempts to give you the opportunity to see better returns than the bank and also outpace inflation without taking all of the risk of investing in stocks. Just keep in mind that these returns are by no means guaranteed and there is still the potential for loss.

Pay Down Debt

???????????????The least exciting option but nonetheless worth mentioning. In this age of incredibly low interest rates, many people have racked up more debt than is advisable because it is “cheap”. Now may be a good time to begin paying off that debt starting with the debt with the highest interest rate and working your way down. It is quite possible that we will see interest rates rise as soon as the end of this year, therefore now would be a good time to pay off debt that has a variable rate of interest like some credit cards for example. Your mortgage is likely a fixed rate (unless you have an adjustable rate mortgage[iii]) so if you have other, higher interest debt you should probably save this one for last.

Well, that is all that I have to say on the topic for now but if you would like a more detailed explanation of the options available to you, please don’t hesitate to reach out! This week our song of the week is in recognition of the end of the 2020 Olympics (still weird to me that it’s not “2021”). Admittedly, I am not big into the Olympics and when I do watch, it is generally the Winter games. However, it’s hard not to get pumped up by this tune! Enjoy!

Song

[i] https://www.kansascityfed.org/ten/2021-spring-ten-magazine/study-shows-surge-in-savings-during-the-pandemic/

[ii] https://www.cnbc.com/2021/08/06/inflation-will-be-the-sizzling-topic-for-markets-in-the-week-ahead-.html

[iii] https://www.investopedia.com/terms/a/arm.asp

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.