Your cash is disappearing

Mar 31, 2021
  • Dennis Lee, Market Insights Lead

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?

A lot of people are choosing 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 at 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.

Not quite getting it?
Below is an illustration of how your money would have been impacted with inflation in your face.

Average annual returns, past 10 years (1/1/11 – 12/31/20), adjusted for 3% annual inflation.

Average annual returns, past 10 years (1/1/11 – 12/31/20), adjusted for 3% annual inflation.

Sources: Morningstar, Bloomberg, BlackRock. Index performance shown as average annual return from 1/1/11 – 12/31/20. Inflation is assumed to be a constant 3% per year. “Stocks” are represented by the S&P 500 Index, an unmanaged index that consists of all share classes of 500 large-capitalization companies, within various sectors, most of which are listed on the New York Stock Exchange. “60/40 Portfolio” is represented by a hypothetical portfolio consisting of 60% of its portfolio represented by the S&P 500 Index and 40% of its portfolio represented by the Bbg Barc US Aggregate Bond Index. “Bonds” are represented by the by the Bbg Barc US Aggregate Bond Index, an unmanaged index that consists of investment-grade corporate bonds (rated BBB or better), mortgages, and US treasury and government agency issues with at least one year to maturity. “Bank CDs” are represented by the annual yield for the Bloomberg CD 12-Month Index, an unmanaged index representative of banks’ certificate of deposit rates over the previous 12 months. “Cash” is represented by the ML US Treasury Bill 3-Month Index, an unmanaged index based on the value of a 3-month Treasury Bill assumed to be purchased at the beginning of the month and rolled into another single issue at the end of the month. US Treasury Securities are direct obligations of the US Government and are backed by the “full faith and credit” of the US Government is help to maturity. Penalty fees may be incurred if withdrawing from a Bank CD before maturity. Bank CDs are FDIC insures up to $250,000, while stocks and bonds are not. Stock and bond prices fluctuate and the value of your investment may change based on market conditions. Past performance does not guarantee or indicate future results. Index performance is show for illustrative purposes only. You can not invest directly in an index.

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. If this is your explicit strategy, then good for you, and best of luck.

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.

But for those who are looking to overcome the math of inflation, we recommend a barbell approach to bonds: effectively, low-cost bond ETFs combined with flexible mutual funds that are specifically designed to seek new sources of return in this crazy world of low rates.

The bottom line

Investors who are 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 quite bizarre – and wrong.

Because in this analogy, you depend on birds for financial security, and that one measly bird is disintegrating in your hand.

Need a quick one-pager to share with others? Download Feeling Safe May Be Risky.