An Inconvenient Truth (About Cash)

April 16, 2008

2087459804 B88ba426fa MIf I told you about a popular investment product that was yielding 40% less than it did last year, you’d probably think it was one of the great financial meltdowns of 2008. But, what if I also told you that investors seemed indifferent to this product’s decreased yield and were actually accelerating their rate of investment? Quite a paradox, no?

As you’ve probably realized, I’m talking about Money Market and Cash investments. Using data from Fidelity, I went back and pulled client statements to see what their blue chip Cash Reserves fund was paying as of March 31, 2007 and March 31, 2008. Over this 12 month period, the fund’s yield dropped from 5% to just over 3% – an astonishing 40% decrease. And yet, the Investment Company Institute (ICI) reports that over that same period Money Market fund assets increased from $2.4 to $3.1 trillion.

The Impact of Inflation on Cash

To make matters worse, inflation is eating away at the long-term value of these cash holdings. With the latest reading of the Consumer Price Index (CPI) at 4%, health care, food, and energy costs are much higher than a year ago. While cash does provide stability and is important for reserve funds, cash now has a negative real return. You can see fairly quickly that if you earn 3% on cash, pay taxes on the interest income, and then subtract an inflation rate of 4%, you now have a negative return of anywhere from 1 to 2% in the purchasing power of your cash.

Maximize those Reserve Fund Returns

With cash holdings generating negative returns in relation to inflation it is more important than ever that you maximize your return on those reserve funds. Having done some research, I’d suggest you at least consider these 2 FDIC-guaranteed banks (needless to say, I have no connection to either of these institutions):

No Minimum:

FNBOdirect.com = 3.25% – First National Bank Omaha

$10,000 Minimum:

WTdirect.com = 3.31% – Wilmington Trust Direct

Listen to the show to hear my thoughts on how this relates to your overall portfolio and my thoughts about investing for the future.

TAGGED WITH: cash, inflation, money market

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