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When Cash is King

I’ve read that keeping cash is not a good idea when you consider that inflation will decrease purchasing power over the years.  For example, in 1981 when I started high school, movie tickets were $2 on Tuesdays.  Today, the same ticket costs between $7 and $12. If I had decided to skip one Tuesday and put my $2 in the bank instead and left if there for 30 years, I would not be able to buy a movie ticket with what was in my bank account today.  The interest rate I earned from the bank and the taxes I would pay on the interest, would make my money less valuable than it was 30+ years ago.  This is even more true today when interest rates are so low.  I’m currently earning 1.8% interest from my bank, but don’t forget I have to pay tax on every penny of interest I make at a rate of 40%!

So I should buy risky investments like stocks, right?  Not so fast.  The big problem with this is when everyone is getting low interest rates, they rush out and buy risky assets.  That make the assets more expensive and increases the risk that the price of those assets will become overvalued and then may collapse.  This leaves me with less money than if I had just left the money in my bank, this is called principal risk.

Another thing to consider and I admit this may not be relevant to most people.  What if you have no debt, lots of retirement savings and are still working and making enough money to pay your bills and still save extra cash.  In this case, cash may in fact be king for two reasons. 

First of all, you can keep your cash for when the stock market corrects or crashes.  Then jump in with both feet and invest.  Markets correct every 2 to 4 years. If you’re lucky and you get a nice 30+% crash, you can make up for years of making 1.8% interest.

Second, somethings actually go down in price over time, mostly non necessities.  If you wait for these things to get cheaper or go on sale, your cash actually gives you a good return.  For example, my wife’s car is a 2001 Mazda MPV and we paid $29000 for it new. In 2012, we can get a similar new car for a little cheaper than $29000.  The real price of that car has decreased significantly over the past 11 years.   Same thing has happened for computers, televisions, air fare, music, and clothes.

Lots of services are also cheaper at certain times.  For example, in a recession home repairs and renovations, hotels, and trips get cheaper.

We actually have deflation for some products and services.  Remember that when you hear that cash is trash.