Ask the Rational Investor: “Isn’t holding cash a lot safer than stocks or bonds?”By: Ryan T. Fulmer
Sunday, July 1, 2018
While it may seem counterintuitive that cash can be riskier than stocks or bonds it can be true depending on your timeframe and liquidity needs. First, let’s discuss the expected returns of stocks, fixed-income (or bonds), and cash relative to inflation. For most investors, they wish to maintain their lifestyle in retirement, but the silent and slow threat of inflation often prevents them from living their best life.
Over very long time horizons, a diversified stock portfolio appreciates the most but has the greatest price fluctuations (or volatility). Realistically, investors can anticipate a long-term return in stocks somewhere between 3-6 percentage points higher than the inflation rate (or 6-9% per year).
Fixed-income instruments such as municipal, corporate, and government bonds have a history of long-term appreciation about 1-2 percentage points greater than the inflation rate. Similar to a certificate of deposit, however, if you hold the bond until it matures the return will be known up-front.
Cash, savings accounts, and money market instruments are important parts of a portfolio. In the short-run, if you have needs for liquidity or upcoming cash expenditures, you wouldn’t want the value of these monies to fluctuate very much. Just imagine one day you go to purchase a new car and the next morning the investments decline in value by ten thousand dollars! Oops!
While cash equivalents play an integral role in your portfolio for the short-term, they can be devastating for the long-term as cash will not produce a rate of return above the rate of inflation. In fact, the chances are that your cash equivalents will lose value relative to inflation!
For many of our clients, their primary goal is maintaining their lifestyle in retirement, a period of their lives that could be 25 years or more. They fear that if their investments do not keep up with inflation, that they will have fewer and fewer assets available to support their lifestyle.
So, is your portfolio built to maintain your lifestyle in retirement? Here are a few steps to consider.
Many soon-to-be retirees focus on the 4% rule, which suggests that you can withdraw 4% each year and not run out of money. While this principle is a little too simple, it is typically accurate. What it doesn’t tell you is if your lifestyle can be maintained after inflation!
As an example, let’s assume you retire at age 65 and need $100,000 every year adjusted for inflation. When you turn 70, that same $100,000 adjusted for inflation at 3% will be almost $116,000! If your portfolio isn’t structured correctly between cash, fixed-income, and stocks, your portfolio may not have grown enough to compensate for inflation. That would be similar to getting your salary cut by 15% in five years!
As you age, and the economy changes, the math gets even worse.
To maintain the same lifestyle of $100,000 at age 80, you would need to withdraw almost $156,000 a year. As you can see, inflation is more worrisome than short-term price fluctuations of the stock market.
We believe that portfolios should be balanced to maintain your lifestyle in retirement while considering your risk tolerance and that a well-thought-out approach is critical to living your best retirement.
Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms. The company serves high-net-worth individuals, families, and non-profits, and has been ranked as one of the largest money managers in Northeast Ohio. Minimum investment $1,000,000.
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