When Cash Is King

cash

I’ve read that keeping cash is not a good idea when you consider that inflation will decrease purchasing power over the years. The interest you earn from the bank and the taxes you pay on the interest, makes the cash you keep less valuable than it was last year. I’m currently earning 1.8% interest from my bank, but don’t forget I have to pay tax on every penny of interest I make at a rate of 40%! Since inflation is currently running at about 2%, my bank deposits are actually losing value every year. Hence the expression you sometimes hear: cash is trash.

So should you put all your money in stocks? Not so fast. The big problem with this is when everyone is earning low interest rates, they rush out and buy risky assets. That make the assets more expensive and increases the risk that the price of those assets will become overvalued and then may collapse. After the collapse you are left with less money than if I had just left the money in my bank; this is called principal risk.

So what are the benefits of keeping some cash, first in the form of an emergency fund and then in high quality government bonds.

First of all, you can keep your cash for when the stock market corrects or crashes. Then jump in with both feet and invest. Markets correct every 2 to 4 years. If you’re lucky and you get a nice 30+% crash, you can make up for years of making 1.8% interest.

Second, somethings actually go down in price over time, mostly non necessities. If you wait for these things to get cheaper or go on sale, your cash actually gives you a good return. For example, my wife’s first car was a 2001 Mazda MPV and we paid $29000 for it new. In 2015, we bought a similar new car for a little less than $29000. The real price of that car has decreased significantly over the past 14 years.

Same thing has happened for computers, televisions, air fare, music, and clothes.
Lots of services are also cheaper at certain times. For example, in a recession home repairs and renovations, hotels, and trips get cheaper.

Remember that when you hear that cash is trash.

Leave a Reply

Your email address will not be published.