One in four Americans (26 percent) say cash would be the best way to invest money that wouldn’t be needed for more than 10 years, according to a recent survey conducted by Bankrate.com. This was the highest percentage of any asset category, with only 14 percent choosing the stock market and 8 percent selecting bonds. It’s understandable, given the recent history of stock and bond markets, why respondents felt most comfortable investing in a safe asset such as cash to store their hard-earned money away for the long term. But what is the real rate of return for cash? To find the answer, one must understand the risk risk of holding cash. Namely, inflation.
When money managers review performance of various asset classes, they do so on a real return basis. That is, they look at the percentage return after taking into consideration the rate of inflation. Over the long term, the Consumer Price Index (CPI), a common measure of inflation, has been measured at approximately 3 percent. With cash and money market accounts currently returning close to 0 percent, the real rate of return on cash would be about -3 percent. Compounded annually over a 10-year period, $100 would be worth only about $74 at the end of the decade. From a real return perspective we can see that this “safe” cash investment does little to help us preserve our capital over the long term.
So if cash isn’t the best place to store our money over longer time horizons, where do we keep it without putting it at risk? Here is where diversification becomes our ally. By spreading our investment out among stocks, bonds and, yes, even cash, we can limit our exposure to risk and create a portfolio that matches our needs. Historically, a balanced portfolio like this has proven to be successful over the long term, providing a positive real rate of return on our investment and outpacing inflation.