Savings rates are still horrid, housing prices are still falling, but hoarding money in a mattress still isn’t wise
Dear New Frugal You,
Just curious: If — and maybe not such a big if — we would want to cash out all our money (investments, CDs, etc.) — would that be such a good idea? I’m afraid that everything will fall like the home and stock market crashes. Even though we wouldn’t be making any interest, is it such a bad idea to take all our cash and put it in a floor safe at home? — Just Curious
Like most of us, events of the past few years have shaken your financial beliefs. That’s understandable. Most Americans counted on their homes and stocks in their retirement accounts to be there for them when they needed the money. That faith has been shaken — understandably.
Housing prices have plummeted. According to the Federal Housing Finance Agency (an agency that regulates Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks), housing prices declined nearly another 1 percent in the fourth quarter of 2010. They have been on a steady decline since 2007. Some experts think that there may be another 10 percent decrease before home prices hit bottom.
The stock market has been no kinder. Many savers saw their accounts drop by 50 percent from their peaks in 2007 or 2008. Then they slowly regained about half of what was lost. But they’re still way below their peak values, with no guarantee of recovery. So, Just Curious, it’s natural that you’d wonder if now might be a good time to put everything in cash and stick it in a safe under your bed. We might even call it a Mark Twain investment strategy. His advice was, “Put all your eggs in one basket and then watch that basket carefully.”
That might be tempting, but it’s not risk-free. Remember that you can’t eat, drink or live in cash. Those dollar bills are only good for what they can buy. They must be traded for food, drink or housing to be of any value.
And that’s where the risk comes in: inflation. We haven’t seen much inflation in the U.S. since the late1970s. Unless you’re 50 years old or older, you won’t remember those days. Back then, prices were increasing at a 10 percent-plus rate. To put that into perspective, at 10 percent inflation, the price of a loaf of bread would double in just seven years. To put it another way, each dollar in your safe has turned into two quarters!
To make matters worse, there’s already a whiff of inflation in the air. If you’ve filled up your gas tank or grocery cart recently, you already know about that.
Plus, there are a number of economic events that are putting upward pressure on prices. Growing economies in China and India are increasing demand. The tsunami in Japan has reduced its ability to supply goods. The European and U.S. government deficits encourage them to print more money. All these conspire to raise prices for you and I.
So putting all your savings in cash is a risky play. It might work out. But I certainly wouldn’t advise it.
A safer strategy is something called “portfolio allocation.” That’s a strategy where you allocate portions of your investments to different choices. Typically, those choices will include stocks (both large and small companies), bonds, commodities (real estate, gold, oil) and cash/CDs.
The idea is that if one class of investments falls, another will increase to offset the loss. History has proved this to be true. I experienced it firsthand as a broker back in the ’80s market crash. As stocks crashed, our bonds went up in price.
And it holds true today. According to the March issue of Financial Planning, if you stayed in a diversified portfolio throughout the past five years, you would be slightly ahead of where you were at the peak in 2007.
The best way to stay safe in these turbulent financial times is to use a strategy that includes a variety of investments to spread your risk. There are various portfolio allocation models available online. You’ll need to select one based on your age and family circumstances. If you’re unsure how to choose, engage a financial planner to help.
Being concerned about your money is wise in this environment. But be cautious so that your concern doesn’t cloud your judgment. Now is a time to study and make deliberate moves with your money. Cashing out probably isn’t a good choice.
See related: Hard times require new investing, credit card habits, Investment choices after retirement funds are maxed out
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