Finance Blog
How to Maximize Your Investment Returns with Your Cash Reserves
How to Maximize Your Investment Returns with Your Cash Reserves
Everyone knows that cash is king, right?
Actually, holding cash can be very risky. Let me tell you why.
I met with a prospective client who was recently widowed. She told me the stock market terrified her and she wanted to keep everything in cash. Her assets were in a six-month certificate of deposit earning a paltry interest of 0.79 percent.
While there is much discussion about deflation, the inflation rate for 2009 averaged 3.85 percent, which is consistent with the long-term average inflation rate of 3.42 percent. The current inflation rate is 1.05 percent.
When the return on your cash is less than the rate of inflation, you are guaranteeing a loss of purchasing power. Here’s an example:
When inflation is running at 3 percent, the value of $100 will drop to $76 in just ten years. Over two decades, the value of that $100 is worth only $56.
An investment strategy that ensures this kind of a loss is very risky.
I am not suggesting that you keep no cash available. Many financial planners recommend having up to two years of living expenses in cash. The cash should be kept in a short-term FDIC-insured savings account, certificates of deposit, Treasury bills, or a money market account with a major fund family, like Vanguard, Fidelity, or Charles Schwab.
In selecting a money market fund, focus on low expenses. The Vanguard Prime Money Market Fund (VMMXX) has an expense ratio of only 0.25 percent. Comparable funds have expense ratios as high as 1 percent. Just say no to them!
When checking bank rates, be sure to look online. The great equalizer is whether your account is FDIC insured. (You can verify whether a bank is FDIC insured by going to the website of the FDIC.) If it is, go for the bank with the highest interest rate.
Once your emergency fund is properly secured, excess cash should be used to eliminate credit card debt. Next, eliminate other consumer debt (like your car loan). If you have a student loan, pay it off or reduce the balance.
If you have dependents, check your insurance. What would they do if something happened to you? Consider purchasing low-cost term insurance on your life. Check out disability insurance. It is often overlooked in financial planning, yet you are three and a half times more likely to be injured during your years of working and raising dependents (and therefore to need disability insurance) than you are to die (and need life insurance).
With these pieces of the financial puzzle in place, you are now ready to consider investing. Some exposure to the stock market—as scary as it may seem—is essential if you want to outpace inflation. Here’s a simple investment strategy:
1. Determine your asset allocation (the division of your portfolio between stocks and bonds). You can do this by taking a short asset allocation questionnaire.
2. Buy three low-cost index funds. Vanguard, Fidelity Investments, T. Rowe Price, and other major fund families offer low-cost index funds that will allow you to diversify your risk without spending a lot of money. Here are three good examples from Vanguard:
- The Total Stock Market Index Fund (VTSMX). Put 70 percent of the amount allocated to stocks in this fund.
- The Total International Stock Index Fund (VGTSX). Put 30 percent of the amount allocated to stocks in this fund.
- The Total Bond Market Index Fund (VBMFX). Put 100 percent of the amount allocated to bonds in this fund.
3. Rebalance your portfolio once or twice a year to keep your asset allocation intact or if your investment objectives or tolerance for risk has changed. Long-term annualized returns from these portfolios range from 8 percent to almost 10 percent—well above the rate of inflation.
Dan Solin is a Senior Vice-President of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read, and The Smartest Retirement Book You’ll Ever Read. . His latest book is Timeless Investment Advice.
Watch Dan on YouTube.
Read More:
Why Timing the Stock Market Never Works
10 Golden Rules All Investors Should Follow
6 Biggest Estate-Planning Mistakes You Can Make
Whole Life Insurance: An Excellent Investment Everyone Tells You Not to Buy
No comments yet
We welcome your interest and participation on this forum, but be aware that comments will be published at Equifax's sole discretion. Please don't use this blog to submit questions or concerns about your Equifax credit report or raise customer service issues. Instead, you should contact Equifax directly for all such matters and any attempts to do so in this forum will be promptly re-directed.
Some other factors to consider when commenting:
- Registration and privacy. While no registration is required to visit our forum, participants wishing to post a message must register by creating an account. All personal information provided by forum members incident to registration is governed by our Terms of Use and Privacy Policy.
- All comments are anonymous. We'll delete your name, e-mail address, and any other identifying information, including details about your investments.
- We can't post or respond to every comment - As much as we'd like to, we can't post every comment, nor can we guarantee that we will respond to each individual message. All questions or comments about your Equifax credit report or similar customer service issues should be handled by contacting Equifax directly.
- Don't offer specific legal, tax or financial advice. All of the materials on this Site are for information, education, and noncommercial purposes only and this forum is not intended as a means of expressing views or ideas regarding any specific legal, tax, or investment advice. While offering general rules of thumb is both permitted and encouraged, recommending specific ideas or strategies regarding investments, taxes, and related matters is prohibited.
- Credit Repair. This blog is not intended as a venue for the discussion or exchange of ideas regarding credit repair or other strategies intended to assist visitors and community members improve or otherwise modify their credit histories, ratings or scores.
- Stay on topic. Your comment should be concise and pertain to the specific post in question.
- Be respectful of the community. The use of profanity, offensive language, spam, and personal attacks will not be tolerated and egregious or repeat offenders will be banned from future participation. We encourage disagreement and healthy debate, but please refrain from personal attacks on our WordPresss and contributors.
- Finally: Participation in this forum may be terminated by Equifax immediately and without notice for failure to comply with any guidelines or Terms of Use. As such, you should familiarize yourself with all pertinent requirements prior to submitting any response through the blog or otherwise. All opinions expressed in this forum are solely those of the individual submitting the comment, and don't necessarily represent the views of Equifax or its management.
Equifax maintains this interactive forum for education and information purposes in order to allow individuals to share their relevant knowledge and opinions with other members and visitors. We encourage you to participate in discussions about personal finance issues and other topics of interest to this community, but please read our commenting guidelines first. Equifax reserves the right to monitor postings to the forum and comments will be published at our discretion. Do you have questions or comments about your Equifax credit report or customer-service issues regarding an Equifax product? If so, please contact Equifax directly. All opinions and information expressed or shared in blog comments are solely those of the person submitting the comments, and don't necessarily represent the views of Equifax or its management.
RSS Feeds