Investment Risks of Holding Cash Include Loss of Interest Payments

When we pointed out that the Oracle of Omaha is sitting on a pile of cash, we do not mean that he is stuffing bills into a really huge mattress. From bank deposits, CDs, and money market accounts to short term bonds, there are many ways to hold cash, make a little money (even at today’s low interest rates) and have ready access to your money. When we wrote about how to invest without losing any money, we talked about how Federal Deposit Insurance now protects bank deposits. And, with bank CDs or Treasuries, you can set up “ladders” where money is always turning over and available for short-term needs. The rate of inflation is low today but it still eats away at the purchasing power of you hidden home cash. When investing in stocks, holding cash until you find the right investment is not a bad idea. And, when you will need your money for things like buying a house or sending a child to college, don’t stay in a risky market. But, over the long term, you are missing out on interest payments when you stash cash.

Investment Risks of Holding Cash Include Missing Out on the Next Market Rally

The reason that many investors are staying in the ever-older bull market is fear of missing out on the next big surge in prices. The rationales are that Trump will fix the trade war, earnings will continue to soar, and high employment will continue. Add a possible cut in interest rates to the picture and you can see why many folks are hesitant to get out of an ever-higher market.

The problem with this line of reasoning is just why long term successful investors like Buffett are holding so much money out of the stock market when they (Buffett especially) have described the US stock market as the best place for your long term investments.

The counter-argument is that folks like Buffett pick companies that will in all likelihood make strong and steady profits into the far distant future. With this idea in mind, they are willing to wait out a market downturn in the belief that that stock prices will recover and continue to climb. This approach was borne out when investors stayed with strong companies through the Financial Collapse and Great Recession.

The Investment Benefits of Holding Cash

When the markets melt down, cash is king. Time and time again, stocks and real estate have taken hits and folks with cash in hand have moved in and used the concept of intrinsic stock value to pick investments that are very cheap only to see their investments grow and prosper over the years.

We see no problem with holding cash so long as you have a plan for how to use it. But, don’t find yourself with hidden cash at home that loses its value slowly but surely as inflation eats away at it.

How Do You Choose Which Assets Classes to Invest In: Stocks

Stocks have two basic things going for them. Over the years the US stock market has outperformed real estate, bonds, and money in the bank. And, the stock market offers liquidity that real estate investments lack. You can buy a stock one day and sell it the next. Try doing that with a piece of real estate! So, why shouldn’t you put all of your investment capital in stocks? If you remember the 2008 stock market crash, the dot com crash, or the various other market crashes going back in time you can see that there can be risk in investing in stocks. There are ways to deal with that risk such as by choosing a range of stocks instead of just one or two and learning to assess intrinsic stock value as a guide to profitable investing.

How Do You Choose Which Assets Classes to Invest In: Bonds

We discussed treasury and corporate bonds in our article entitled how to invest without losing any money.

US Treasury bills have maturities of a year or less. US Treasury notes have maturities from two to ten years. And, US Treasury bonds have maturities of ten to 30 years. Each of these investment vehicles is backed by the “full faith and credit” of the US government. The risk of loss of any of these if held to maturity is nil.

How to invest without losing any money in US Treasuries is to hold them to maturity or only sell them at a profit.

The same approach applies to AAA corporate bonds issued by Johnson & Johnson or Microsoft. These asset classes do not outperform the S & P 500 over the years but they do outperform a lot of individual stocks. If want you want is to keep your money safe, not lose any, and make a decent rate of interest along the way, bonds as an asset class are a good addition to any investment portfolio.

How Do You Choose Which Assets Classes to Invest In: Cash and Short Term Investment Vehicles

If you believe you will need your money fairly soon, you do not want to tie it up in stocks, long term bonds, or real estate. Any of these asset classes may go into a slump and that would mean that you lose money when you take your cash. A good way to get a little interest on your money is to create a ladder of short term bonds or even CD’s at your bank. You will always have cash available when needed. This asset class does not outperform any of the others but it is the most flexible. There are a lot of smart investors who hold cash when they do not trust which way interest rates, the stock market, or real estate prices are going.

How Do You Choose Which Assets Classes to Invest In: Real Estate

Your own home is the real estate investment that you need to make first and foremost. Long term real estate investment is a skill that needs to be developed over the years and hopefully not by losing money along the way. If you want to take advantage of profits from real estate and not sink all of your money into a piece of property, consider REITs which are real estate investment trusts. These are investments you can get  into for a reasonable amount of money and get a good return. And, you do not need to manage the property yourself!

How Do You Choose Which Assets Classes to Invest In: Gold

Gold bugs think that sooner or later all paper currencies will be worthless. Thus, the only way to retain any value for the future is to hold precious metals. The problem with gold is that it does not pay a rate of interest and its price goes up and down. If you want to have a little gold as a reserve, just in case, there are to viable approaches. One is to simply wait for the price of gold to plummet and then buy. The other is to use cost averaging. Buy the same dollar amount of gold every month or so. Gold is a valid hedge against catastrophic economic and social events but the S & P 500 has been a better choice over the years.

How Do You Choose Which Assets Classes to Invest In? PPT

The Stimulus Package and Inflation

Throwing trillions of dollars at the current economic crisis may well be the only way out. Or, as the President implies it may be the only way to keep the US out of a long term depression. Right now the stimulus money is meant to replace currently unavailable credit and encourage spending. Over the long term as credit is freed up and asset values rise the trillions of dollars dumped into the economy may well have been excessive. In that case how much inflation will we see?

It is interesting that the US Treasury brought back 7 year notes and that the three year notes recently sold well. As treasury auctions go forward it may well be that the 3 and 7 year notes will sell well and not the 10 and 30 year notes. That will be the case if investors believe that the dollar will continue its inflationary slide in a few years.

The Economy and Deflation

The US savings rate is going up, finally. For years economists have warned that the poor US savings rate decreased available money for investment and was a problem. Now the US consumer is saving instead of buying and that is a problem as the economy is going into a worse slump. Will the US see deflation such as Japan had in the 1990’s? With poor credit and half the value of the stock market gone cash has resumed its historic importance.

Although folks bought the 3 year notes the interest rates bid were lower than expected. This would seem to indicate that investors merely want their cash in a safe place and that these investors are concerned about deflation and not longer term inflation. When the 10 and 30 year auctions take place we will see a better indication of investor sentiment for longer term inflation versus deflation.

With too much production capacity around the world trying to satisfy too little demand we may see price deflation across the board. That’s great for consumers and bad for workers. The United States reported historically high productivity this last fall. That’s great for competing businesses, great for consumers, and likely to lead to deflation.

As things become less and less costly cash becomes more valuable. In the inflation of the 1970 consumers “invested” in lawn chairs and garden hoses because buying later was always more expensive. Now in deflationary times it makes sense to wait and sit on your cash. But, where do you put your cash? Short term treasury notes will return your money in a few years or, if deflation really takes hold you can sell at a tidy profit.

The Stock Market and Inflation or Deflation

Our opinion, voiced on these pages, is that investment in companies likely to benefit from US infrastructure improvements will pay well in the next years. Whether we see inflation or deflation it still appears that the stimulus money is coming but it takes time to design bridges, water treatment plants, highway improvements, etc. Then there is the bidding, hiring, etc. Experts are saying that local hiring for US infrastructure projects will not result in paychecks for about a year. That means that the increased consumer spending anticipated is a year off. On the other hand the market anticipates. Putting you assets in cash (3 year treasuries) while you research promising stocks is perhaps not a bad idea.