In Love With Cash?
By Ben Dolan, CFP®
My high-yield money market account is yielding 4.0%. This is where I keep my emergency fund. If the current heat wave knocks out my AC, I’ve got the cash ready to go and Morris Jenkins in my favorites.
I have a little bit of cash in my portfolio as well (roughly 1%). This morning rates on 1-yr CDs ranged from 5.0% to 5.2%. Short-term treasuries, which are not subject to state income tax, ranged from 4.9% to 5.2%. These returns on cash are fantastic, especially compared to rates just a couple of years ago. According to macrotrends.net, short-term treasury yields closed 2021 at 0.39%.
Cash rates look even more favorable given recent news on inflation. Last week the Wall Street Journal reported that the consumer-price index (CPI) climbed 3% in June from a year earlier. This is welcome news, and I’m cheering for the CPI to normalize to its 2% target as soon as possible.
While I’m enjoying these rates and the improved inflation numbers, I can’t help but wonder…what is my “real” return on cash? Real return is defined as the annual percentage of profit earned on an investment, adjusted for inflation. In other words, return minus inflation.
Despite the decrease in June, through the first 6 months of 2023 inflation has averaged 4.8%. Assuming I made 5% on cash, my real return is 0.2%. Not so great. Especially considering that investing cash is not my only option.
I wonder how my real return on cash compares to the real return on my portfolio? Keep in mind, I’m relatively young (my kids would laugh at this!) at 43, and I have a high-risk tolerance (my portfolio is 100% to stock). Year-to-date, my portfolio has returned almost 13%, providing a real return of 8.2%. That’s an 8% difference versus cash!
This is not a fair comparison given that markets have done better than their respective long-term averages so far in 2023 (not far off though, given the 20-year return of 9.8% for the S&P 500), but the point still holds: if you’re looking for good real returns that increase your purchasing power then you should consider an appropriate allocation to a diversified stock portfolio held for the long-term.
The uber-wealthy can afford to earn cash rates given the size of their nest egg. But many investors with average portfolio balances have exited the stock market to invest in cash. If they calculate their real return, they may not like what they see.
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