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Cash Is A Clunker
By: Charles Lieberman
Date: 8/31/2009
Many investors are trapped in cash out of concern they have missed the stock market rally. They fear it is too late to buy, since stocks could easily go down from current high levels after the 50% rally from the March 9 low, so they sit (unhappily) in cash. It is our firm judgment that holding cash is a mistake. But, how do these investors get back in? These investors who are paralyzed by the market should start with small positions in conservative stocks and build their holdings over time, as they see that the economic recovery is for real and they regain confidence to get invested.
Sitting in cash today is a disaster, especially for any individual who lives off an investment portfolio. Money funds, bank accounts and bank CDs offer very low interest rates, so many such investors must tap into principle, which depletes their capital base. Moreover, even low rates of inflation erode the buying power of that capital over time. While cash is not often considered an investment class, theres little doubt that holding high levels of cash is devastating to investors while interest rates remain at low levels.
Will interest rates rise enough anytime soon to make cash a worthwhile investment in the future? Sure, but only if the economy improves. The Fed will not raise interest rates until officials are absolutely certain that economic recovery is well entrenched and they can afford to take the risk that rate hikes will not hurt the economy. Thus, until solid economic growth is locked into place, rates must remain low. By the time the economy recovers to the point that the Fed can raise interest rates, it is very likely that stock prices will be considerably higher, in anticipation of the rebound in corporate earnings. So if investors are holding cash because they are hopeful that a recovery will give them better yields, they are missing out on the even better returns they might earn in stocks.
So, what should fearful investors do? If an investor cant bring themselves to reallocate a significant portion of their portfolio back into stocks, then they should at least get started down that path with regular, smaller reallocations as part of a systematic investment program. They could start by allocating 10% of some predetermined amount to be invested monthly. If the market declines sharply halfway through the program, they know that the second half of their investment plan will buy shares at lower prices. If the market rises instead, at least they got half their money into the market at low prices. Holding cash will not solve the problem and it will leave the investor worse off over time, as principle declines from withdrawals and inflation. It is not too late to start.
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