With changes in the financial landscape, you may be wondering how aggressively you should invest in cash. What is the right ratio when determining how much cash versus investments? How much of my portfolio should be in cash? Is cash king during inflation? These are great questions.
Markets are highly volatile, so having cash available to make investments during a market decline is valuable. And of course, we all know cash can be used for living expenses or invested in short- and long-term goals. However, the downside to keeping excess cash is, when adjusted for inflation, your real (inflation-adjusted) return is likely to be below zero.
The annual inflation rate for the United States in 2022 was 6.5%, and we believe it will stay high for some time. Too much cash left sitting in a bank account is costing you money. That’s why it’s even more important to invest in cash strategically. So, cash may not be king during inflation, but that doesn’t mean you should stop holding an allocation in cash altogether.
What is the short-term outlook for cash?
In the near-term, cash is an important asset to have. While high inflation is slowly eating away at the purchasing power of cash, having liquidity that can be quickly deployed may offer some level of safety and security. Short-term cash investments can provide flexibility and allow you to take advantage of short-term market movements or discounts. Given that a recession in 2023 seems likely, in our view, holding some extra cash to take advantage of a bear market seems like a good idea.
Additionally, with cash, investors need to find the right financial institution and deposit their funds. Short-term Treasury notes, for instance, are a cash equivalent and today provide a yield-to-maturity. While lower than the inflation rate of 6.5%, a +4.6% income yield is better than many other investments are likely to provide, especially if there’s a recession in 2023. For that reason, it probably makes sense to have a larger-than-normal allocation to such investments.
What is the long-term outlook of cash investments?
Over the long term, holding too much cash is likely to be detrimental to investment returns. Investors should be mindful that cash investments are generally less likely to deliver the same level of returns as other riskier investments. To maximize returns without taking on excessive risk, investors should consider diversifying their portfolio with other asset classes such as stocks, real estate, or commodities.
While we expect inflation to moderate somewhat in 2023 due to the weakening economy, we believe it will remain elevated above historical levels for the next 5-10 years, meaning that cash will be devalued over time. A major risk with cash investments is that they will not generate returns above inflation, meaning if you leave your money sitting in a bank account, it’s likely going to depreciate in purchasing power over time. That’s why it’s important to invest your cash wisely and diversify across assets to minimize how much your purchasing power erodes when inflation is high.
Check out the information on our website to learn more about investing in cash or contact one of our financial experts today.
This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy,” dba Pekin Hardy Strauss Wealth Management) for informational purposes only and is not intended as an offer or solicitation for business. The information and data in this article does not constitute legal, tax, accounting, investment, or other professional advice. The views expressed are those of the author(s) as of the date of publication of this article and are subject to change at any time due to changes in market or economic conditions. Pekin Hardy cannot assure that the strategies discussed herein will outperform any other investment strategy in the future.