Wednesday, August 24, 2011

When Cash is a Good Idea

Most of my friends, relatives and colleagues think my strategy of holding cash is a bad one.  They remind me that inflation will reduce the value of cash while equities will keep up with inflation.   They also remind me that I can't successfully time the market.  Statistically, they are correct.  Cash will be worth less due to inflation and unlike stocks, cash won't appreciate. However, if I have sufficient cash, inflation and lack of appreciation don't matter.

Let's talk first about inflation.  If I assume inflation of 2%, then my cash will decline 2% in value per year.  What does that mean?  In 5 years, my cash will lose 10% of its value, 10 years, 18%; 20 years , 33%; and 35 years, 50%.  OK, 35 years sounds pretty bad for cash, especially if I a need the money in retirement.  However, let's assume I have a good pension and Social Security.  Also, I only need $20,000 a year of supplemental funds.  If I had $1.5 million in cash, I probably wouldn't care about only keeping it in cash.   That's because even after 35 years, it would still be worth $750,000, which still cover 37.5 years of $20,000
a year payments.

What about appreciation?  Well in the example above I don't need appreciation either.  Appreciation is nice to have but it's not necessary.

So cash is good when you have enough funds, despite inflation and no appreciation.   At that point, there is not need to take any unknown downside risks, such as investing in the stock market.
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This is not financial advice. Please consult a professional advisor.

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