Money Markets Are Dangerous!

February 28th, 2007  |  Published in Asset Allocation  |  2 Comments

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.

Exchange Rates
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.

Inflation
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.

  

Responses

  1. fivecentnickel.com says:

    March 3rd, 2007 at 12:41 am (#)

    Weekly Roundup – 03/02/07…

    Here’s a quick look at some of the articles that caught my eye over the past week:

    FMF shed some light on how they’re budgeting for their Disney trip. If they were regular visitors (doesn’t sound like they are, though) I’d rec…

  2. Shadox says:

    March 3rd, 2007 at 8:59 pm (#)

    Your comments are correct, however:

    1. The exchange rate comment is basically a geographical diversification comment. It is true for all investments that are confined to the US, whether they are in money markets, bonds or stocks. BTW some say that the dollar is due for an even bigger drop over time given the federal and trade deficits. If that is the case foreign investments will do even better in the long run if the investments are denominated in foreign currency.

    2. The inflation argument is equivilent to the opportunity cost argument. Both arguments conclude that money market investments do not provide adequate returns. Both arguments are correct.