What’s that? How can you lose money if it's sitting in cash? Because of that pesky thing called inflation. Over the years I’ve learned that we tend to think in nominal terms rather than real terms, adjusted for inflation. The Bureau of Labor Statistics defines inflation: “………as a process of continuously rising prices, or equivalently, of a continuously falling value of money”. Given today’s low-interest rate environment when you adjust your savings account interest rate for inflation you actually come up with a negative return.
As an example and using Bankrate’s national average savings and money market interest rate of 0.11% and inflation of 1.60% (The latest inflation rate for the United States is 1.60% through the 12 months ended November 2016) you get a negative return of (1.49%).
0.11% – 1.60% = -1.49%
In other word’s, if you left your money in a savings money market account for a full year under the same circumstances you would end up losing 1.49% in purchasing power. When having this conversation with customers they tend to look at me like a puppy with their head tilted a little to the side as if what I said was something from another planet. No, inflation is not from another planet and the loss of purchasing power is real.
I believe that most financial plans need to have a cash component. Be it to serve as an emergency fund or for a specific goal that requires short-term liquidity. But under very few scenarios should there be anything close to 100%. You might ask, what percent should I have in cash? The answer depends on your current financial situation that you and your competent financial advisor can address.
Hermes Conesa CEO @ Simpleivest