Christian Community Networking

 Mr. William Milton

Stocking Up on Cash: Scared or Prepared?

About half (49%) of Americans have put away enough money to cover their expenses for three months in case something happens that could disrupt their incomes.1 This is good news.

Having enough cash to make it through an illness, injury, job loss, or other financial emergency can help you avoid taking on debt or tapping your retirement assets. However, given the relatively low interest rates offered on cash instruments, having more cash in your portfolio than would be necessary to cover three to six months of expenses could actually say something about your long-term outlook.

If you have been increasing your cash position, it’s a good idea to be honest with yourself about your motives. Ask yourself some critical questions.

What am I saving for? Building up a cash reserve to help defend against the unexpected is a smart move. But are you working to accumulate a particular sum, or is there no end in sight? You run the risk of not reaching long-term financial goals when your portfolio is too heavily allocated to cash.

Am I increasing my cash position because of fear? It’s usually not a good idea to keep the bulk of your wealth and/or retirement assets on the sidelines, in low-yielding cash instruments, just because you fear market volatility. Of course, as retirement approaches, it’s a good idea to begin shifting assets into more conservative positions. But this process should be based on a forward-looking strategy that takes into account your time horizon and risk tolerance, rather than on an emotional reaction to market fluctuations. As you can see in the chart above, trying to pick the right moment to flee and the right moment to reinvest is a costly practice that can cause you to miss out on market gains.

What’s my real rate of return? Despite the fact that inflation has been fairly low over the past few years, it is still growing at a faster rate than most cash instruments. For example, in 2009 the rate of inflation was 2.72% and the annual yield on six-month certificates of deposit was 0.81%.2 What this means is that the combined principal and interest that was returned to the CD owner on the maturity date had less spending power than the principal that was invested six months earlier. When you also consider the effects of income taxes on the interest earned, it’s easy to see how expensive “safety” can be.

The FDIC insures bank savings accounts and CDs, which generally provide a fixed rate of return, up to $250,000 (per depositor, per institution). The return and principal value of an investment in stocks and bonds fluctuate with changes in market conditions. When sold, these securities may be worth more or less than the original investment amount.

There’s a big difference between being prepared for unexpected expenses and stockpiling cash because of fear. We can help you evaluate the role that cash plays in your portfolio.

1) Journal of Financial Planning, March 2010

2) Thomson Reuters, 2010, for the period 12/31/2008 to 12/31/2009. Inflation is represented by the U.S. Consumer Price Index. CDs are represented by the 180-Day Certificate of Deposit Index. The performance of an unmanaged index is not indicative of the performance of any particular investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Actual results will vary.

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2010 Emerald.

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