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What Cash Can and Can't Do

With higher interest rates on the horizon and volatile stock markets, you might think that this is a good time to steer clear of the markets and just keep your money in cash.

In uncertain markets, cash can seem like a neutral choice, a way to press pause on the soundtrack of the market. It can also quiet the feelings of fear or worry you might have about Europe or interest rates and bring you a sense of stability and certainty. Every day, you’ll see the same numbers in your bank account and you’ll know that it’ll be there tomorrow, too. That’s a valuable feeling, but that feeling can be very costly.

Cash isn’t risk-free. That’s a common myth. Cash has risks, but these risks are different than the risks you’ll face when you’re invested in stocks or bonds. You should understand and manage the risks of cash in the same way that you’d consider the risks of investing.

Cash has its place

Cash is an important part of your overall investment plan: you need to keep some of your money in cash to cover your day-to-day expenses and in case of any unexpected events or emergencies. You wouldn’t want to have your emergency fund invested in stocks or bonds because these investments can lose money, particularly in the short term.

Cash can become a problem, however, when it replaces stocks or bonds in your long-term investment plan.

Cash isn’t a substitute for stocks

In volatile markets, you might think that being in cash could work out better than staying invested in stocks. You might reason that by avoiding stocks, you’ll avoid losses. But history shows that moving to cash, even just for a few months, can also mean avoiding gains.

We talked with an investor in the Upgrader Fund (FUNDX) whose returns were far lower than the ones shown here. We went over each year of returns together, and we eventually found the problem: he’d sold out of the fund and gone to cash at a crucial point in the market, and by the time he got invested again, he’d missed out on gains. It didn’t seem like a big deal at the time, but as the years passed, it was clear that this one decision had made a big impact in his results.

We all know the risks of taking too much risk: if we invest too much in stocks, we could lose money. But we often overlook the risk of being too conservative. If we don’t take enough risk, we may fall short of our investment goals or run out of money in retirement.

When we’re considering investing in stocks or cash, we need to make sure we’re thinking seriously about time. Stocks may feel risky today, but over the long term, stocks have reliably had gains. Remember stocks have always had gains over every 20-calendar-year period since 1950. Cash may feel safe today, but it can have significant risks down the road.

Cash isn’t a substitute for bonds

Cash also shouldn’t be a substitute for fixed income. Given the low interest yields of money market or checking accounts, cash actually loses value over time due to inflation. But bonds and bond funds usually pay higher dividends than cash accounts, so they have the potential to grow over time; cash doesn’t. Over the last five years, the purchasing power of cash has decreased, while investments in bonds have grown, even after factoring in inflation.

Bonds have another advantage: they sometimes rise when stocks fall. This means that a portfolio of both stocks and bonds could hold up better in market declines than a portfolio of stocks and cash. If you keep your fixed income allocation in cash, you risk missing out on some pretty good returns and the opportunity to benefit if bonds gain as stocks fall.

Stuck in Cash? How to Get Back on Track

If you’ve been in cash when you know you need to be at least partially invested, then there’s no time like the present to get back on track.

Make a plan

Don’t wait for the ‘perfect’ time to invest because that time may never come. Instead, make a plan—decide how much of your cash you’re going to invest and then schedule when you’ll actually put that money to work. When we’re investing a client’s account, we’ll often invest 30-50% of the portfolio right away. This way, the client has meaningful participation in any market gains that occur while we’re putting the rest of the account to work. Then we invest the rest of the portfolio gradually on a set schedule, perhaps every week or every month.

Write it out

We often pencil out exactly how we’ll invest their portfolios, and then we calendar these changes. You might consider doing the same. By deciding in advance where you’re going and how you’ll get there, and writing it out so you can refer to it later, you’re more likely to follow through, even as markets change.

Balance your portfolio

Not sure where to invest? Balanced portfolios like the Conservative Upgrader Fund (RELAX) can be a good option. RELAX has 60% in core stock funds for potential long-term growth, and it has 40% in bond and total-return funds for stability in difficult markets.

Disclosures:

Past performance does not guarantee future results. A Lipper Fund Award is awarded to one fund in each Lipper classification for achieving the strongest trend of consistent risk-adjusted performance against its classification peers over a three, five or ten-year period. Although Lipper makes reasonable efforts to ensure the accuracy and reliability of the data contained herein, the accuracy is not guaranteed by Lipper. Lipper Analytical Services, Inc. is an independent mutual fund research and rating service. © 2016, All Rights Reserved.

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