Many people have believed that cash, as an investment, is safe but it isn’t and it’s the subject of Walter Updegrave’s latest column in which he explains why cash (“invested” in traditionally safe vehicles) is risky. While Updegrave focuses on the opportunity cost aspect of it, how the money can be earning higher returns elsewhere, such as in a 401K; I think that doesn’t do as well of job explaining the entire story – there are a couple reasons why cash is risky.
The value of a dollar, on the international markets, fluctuates every single business day and lately, it’s been at record lows compared to other currencies. You may know that all the money that hold, those are dollars and as each day passes there is a risk that your dollar is going to be worth less and less (or more and more) each day depending on the demand in the world markets. Usually this won’t affect you since everyone around you accepts dollars, so you won’t need to exchange them, but as anyone who does a fair bit of traveling knows, exchange rates can mean the difference between cheap and expensive vacations. So, when you keep your money in a money market, and perhaps too much of it, you’re not diversifying on the basis of country risk – which is risky.
By now everyone is familiar with inflation, it’s like an exchange rate but for time. As time passes, your dollars are worth less and less. A hundred bucks in 1970 is worth $521.69 today (2007)… a hundred bucks in 1913 is worth a cool $2,044.61 today! Unless you invested correctly (i.e. earned a rate of return higher than inflation), your $100 in 1913 would be worth only $100 today.