Spread the love

The Federal Reserve has now held short-term interest rates at close to zero for over six full years. Six years – that is 2,190 days, and counting! It is no wonder that finding a reasonably safe way to earn a return on cash has become one of the biggest questions on investors’ minds.

In fact, some of the most frequent questions I field these days are about this topic:

  • What should I do with my cash?
  • Do you think interest rates are going to go up soon?
  • Why hold any cash at all in my portfolio?

Reflecting on these questions today, I would like to make the case that a money reserve, counter-intuitively, is actually more valuable today than it was six years ago, even if interest rates remain close to zero.

Low Confidence in Greenbacks

The Fed created the present crisis of confidence in cash holdings by design. Policy makers are actively trying to burn a hole in everyone’s pockets by holding interest rates at close to zero. They want consumers to spend, spend, and spend some more. They want the public to behave like three-year-olds flush with coins at the candy store (not to mention the line of people standing outside of Target in the snow at 6 p.m. after Thanksgiving dinner!)

While the Fed’s policy prescription has successfully propped up consumer spending to some degree – auto sales are back to pre-crisis levels, for example – it has had a far more profound impact on the psyche of investors, from retirees worried about portfolio income, to professional investors paid to “beat the market.”

“But, Returns Are So Low”

An oft-cited argument made by pros and retirees alike is that, with the return on cash so low, these holdings have no value, and, therefore, one must invest in ever more risky financial assets to earn anything remotely resembling an acceptable return. This argument against holding cash has been dubbed T-I-N-A, “There-Is-No-Alternative” to owning stocks and “high-yield” bonds. Investors have taken the Fed’s bait, hook line and sinker – from emerging market stocks to junk debt, the riskier the better.

C-A-$-H has become TINA’s favorite four-letter word.

TINA has long forgotten the wise market adage that “holding cash is uncomfortable, but it is not as uncomfortable as doing something stupid.” Unfortunately, the odds of doing something stupid with your money has increased significantly these past six years, right along with the dramatic increase in the prices of risky financial assets.

I assert that the discomfort associated with holding reserves may be lessened by reviewing some of the following excellent reasons in support of holding at least some C-A-$-H:

  • Income replacement: As an emergency reserve, recommended as at least 3 months for a working family, and at least 2 years worth of spending for a retired family
  • Inflation protection: Because of its zero duration, cash fares better than bonds in an inflationary environment, assuming that the Fed seeks to raise cash rates in response to inflation, as it did in the 1970’s.
  • Deflation protection: Money is also a pretty good deflation hedge. As the price of goods falls, it gains value in real terms. This is referred to as an increase in purchasing power.
  • Dry Powder: When financial asset prices are high, cash can be extremely valuable – especially when no one else has it. Cash does well in the initial stages of a financial asset bubble bursting – witness 2001-2003 and 2008-2009.
  • Liquidity: Having cash on hand can be the difference between getting in on the best buying opportunities, or missing out completely.

There are many forms in which to hold cash, and certainly some are much better than others. There are also plenty of intelligent ways to deploy cash that are not stupid. It takes hard work and discipline to deploy cash intelligently in today’s environment, and to avoid making stupid mistakes.

The bottom line on C-A-$-H: you don’t have to settle for zero – but zero still beats stupid.

Talk with us about how much cash is the right mix for you.

Free Portfolio Assessment