The Risk of Sitting on the Sidelines
We have seen a record amount of new home purchases and refinancing largely due to historically low-interest rates and a response to the pandemic in the past year. This is undoubtedly good news for borrowers. However, as Newton taught us, “for every action, there is an equal and opposite reaction.”
Low-interest rates are not good for savers, as we are earning historically low amounts on cash and other short-term investment vehicles. This presents a risk to the purchasing power (inflation-adjusted) of our assets. Blackrock, with just under $9 trillion in assets under management, provides insight on this topic as well as actions to take in today’s low-interest-rate environment.
Your Cash is Disappearing
(by Dennis Lee, Market Insights Lead at BlackRock with emphasis by Madison)
“In recent weeks, there have been people risking their wealth on speculative memes, and then there have been the rest of us, who have been taking on a different kind of risk altogether – the risk of not taking any.
Are we in a bubble? Are prices too high? Where’s the safest place to park my money?
Many people choose to leave it in cash, or put it in an investment that resembles cash, like a money market fund, certificate of deposit (CD) – or worse, a savings account.
In January, money market fund assets reached $4.3 trillion, more than any point in history. The pandemic has likely magnified this, as consumers have benefited from fiscal stimulus and are spending less while staying home. The BlackRock Investment Institute estimates that consumers in the U.S. have 12% excess spending on average compared to last year.
The risk of playing it safe
Why is this a problem? The math alone won’t convince you, but we’ll provide it here anyway.
As you might know, the Federal Reserve has set rates at historic lows, which reflects rates in money market funds (0.09%, as of 12/31/20)*. Never mind that a near 0% return on any investment would be less than ideal, but it looks increasingly like inflation may reach at least 2% for quite some time.
Below is an illustration of how your money would have been impacted with inflation in your face.
The above shows that cash or a cash-like investment like a CD would have brought in negative money after inflation.
Some investors love their guarantees on cash. Right now, holders of cash may be guaranteed to lose money after inflation.
What to do about it
If you have a long-time horizon, the above chart should tell you that simply putting the money to work somewhere could lead to a better result than doing nothing or holding cash.
There are legitimate reasons to hold cash in a portfolio as an investment strategy. But almost all of those reasons boil down to having flexibility when putting it to work. Good for you, and best of luck if this is your explicit strategy.
But most investors may be holding cash because they are concerned or want to be conservative in their investment approach. Their cash isn’t really a part of their portfolio – they are simply not including it as part of their investments.
At the very least, they ought to consider short-duration bonds, which can potentially yield more than the close-to-zero returns.
The bottom line
Investors sitting on cash might subscribe to the phrase ‘a bird in the hand is worth two in the bush.’ But as soon as you extend the analogy, it becomes pretty bizarre – and wrong.
Because in this analogy, you depend on birds for financial security, and that one measly bird is disintegrating in your hand.”