How Cash Can Earn You More Than 0%
Do you know the interest rate you’re earning on your savings account? The last time I checked, my “high-yield” savings was paying a meager .4%. When savings accounts pay nearly 0% in interest, as they did from 2002-2004 or 1992-1994, it is tempting to think of cash as a worthless investment.
But as investors found out during the Covid-19 crisis, 2008 financial recession, and many recessions prior, cash was anything but worthless. Cash gives you options when the world comes to a screeching halt. And those options can save you a lot of money.
During a recession, it is important that you have enough cash to -
(1) Ride out any reasonable bear market. If you are still working, you should have at least 3-6 months of expenses in savings. If you are retired and withdrawing from investments, you should have at least 2 years of expenses in cash or short-term safe bonds and 3 or more years in medium to long-term bonds. This provides a place for you to draw from without having to sell stocks when they are down. For example, if you need $6,000/month from investments, you should have roughly $150,000 in cash or safe bonds and another $200,000 or more in medium to long-term bonds.
(2) Sleep well at night. This is often overlooked. It’s tempting to think of ourselves as investing robots. But we’re all humans and it’s important to remember that when making decisions about how to allocate your investments. Taking the example above – you might only need $350,000 in cash and bonds but that amount still makes you nervous. If you can afford to take less risk AND understand the tradeoff of taking less risk, it is certainly okay to do so!
If you don’t hold enough cash, the alternative of selling when the market is down, is extremely costly. For example, if you had taken just $100,000 out of the stock market in 2009 and put it in savings because you didn’t have enough cash, you would have lost out on $400,000 of gains over the next 10 years – an annualized return of over 17% - not bad for cash that’s just sitting in a savings account!
Thank you for reading,
Alex
This blog post is not advice. Please read disclaimers.