Keeping cash is great for your psyche but horrible for your long term financial well being. What most people fail to understand is that cash is designed to be worth less in value over the long term. Here in the United States we have an organization called the Federal Reserve. Their sole purpose is to determine our country’s monetary policy. Simply put, they determine our bank’s interest rates and how much money is printed and put into circulation. Their main focus is to keep our financial system healthy and the rate of inflation at around 2%.
The key term in that last sentence is the word INFLATION. Their goal is to have the average cost of goods and services go up by 2% a year. To look at this from another angle, you could say that their stated goal is to have the value of cash go down by 2% a year. And honestly, some years they suck at their jobs, and they value of your cash can drop by as much as 4-5% in a single year. In the late 70’s and early 80’ the United States experienced annual inflation rates of 10-13%.
Let’s use the example of high inflation in the late 70’s and early 80’s. How would you feel if you were to put 100 individual $1 bills into a drawer in 1979 and when you opened the drawer in 1983, there was only 69 individual $1 bills left in the drawer. This is with no one touching the money, the drawer has never been opened. It is almost as if the money evaporated. That is the dramatic impact that inflation will have on you if you keep all of your savings in cash.
If you stop to think about the past and ask yourself, “how much did “X” cost 50 years ago”, nearly 100% of the time “X” will always be way less. For example, How much did a nice pair of shoes cost in 1967? The cost of women’s shoes ranged from $4 to $10. These are nice quality shoes sold at Macy’s we are talking about here. Currently comparable shoes will cost you $30 to $60. That is over a 7.4X increase in the cost of shoes! Or once again a 7.4X decrease in the buying power that your cash has to buy the same item.
How did this happen? Like I said earlier, the goal of the federal reserve is to have the average rate of inflation go UP by 2% every year. Using that metric we can do some simple math and see what the result of their plan looks like. So, we take our $4 and $10 department store women shoes (in 1967) and plug it into a formula for compounding interest. It looks like this: (4(1.04095)^50 = $29.76 or (10(1.04095)^50 = $74.40. So what does this gibberish mean? What the above formulas translate to is the following: the average rate of inflation for the time period of 1967-2017 was 4.095%, when applied to the $4 shoe and ran over 50 years, you end up with that shoe costing $29.76 in today’s dollars. When the same is applied to the $10 shoe you end up with it costing $74.40 in today’s dollars. You can use the calculator supplied by United States government here https://data.bls.gov/cgi-bin/cpicalc.pl.
So what the hell does this all mean and what is my point? My point is this – if you are just starting out and saving for retirement, and plan on keeping just a huge stockpile of cash, don’t. If you think that you’ll need $1 million to retire comfortably, you will be extremely upset when you find out that it will only be worth $137,539.69 in future dollars. Or put another way if you want the purchasing power of $1 million dollars today, it will have to be approximately $7.4 million dollars 50 years from now. So in regards of the impact that inflation has on your cash, time is NOT on your side.
What should you do then? INVEST YOUR MONEY. The cool thing that happens is just like the cost of the shoe being 7.4 times more than in 1967, you could point to assets and see a similar correlation, if not more dramatic correlation. What was the level of the S&P 500 in 1967? Amazingly it was $84.45, currently it is trading at $2,444.24. That is almost a 29 times multiple (or 29 times as much, for all the lay peope out there). It blows the shoe multiple out of the water! How about real estate? In 1967 the median price of a new house was $22,200. In 2017 that cost has risen to $313,700. So in that example the value of the real estate has risen by a multiple of 14.
As a final and hopefully illustrative example we will use 3 fictional characters who are brothers. Their names are Joe Investor, Frank Investor, and Dick Investor. The year is 1967 and all 3 brothers inherit $25,000 each from an Uncle who died. Joe Investor decides that he is going to invest that money and buy a well diversified stock portfolio with the proceeds. Frank says that he would feel it would be best if he bought real estate with his inheritance and buys a single family home with the money he received. Then there’s Dick, he says that the stock market is rigged and he doesn’t feel like plunging toilets and all of the other headaches associated with real estate. So Dick decides he’s going to put the money in a safe deposit box, for “safe keeping”, of course!
It just so happens that all 3 gentlemen decide to use the proceeds from their inheritance exactly 50 years later. The first brother, Joe, who bought the diversified portfolio of stocks is delighted to see that his original $25,000 investment has grown to $723,576.08 in the year 2017. The second brother, Frank, decides to sell the single family home that he bought in 1967, and is pleased to see that he will be getting a windfall of $353,265.76. And then there’s Dick. Dick is not too happy! Seeing how Joe is nearly a millionaire, and Frank thinks he’s some sort of real estate guru. All dick has is $25,000 and it doesn’t even buy a house like it use to in 1967.
So what is the moral of the story? Don’t act like Dick, and don’t keep your money in cash. I really hope you enjoyed reading this as much as I enjoyed writing it for you. If you have any questions or comments feel free to contact me via the email address provided. Also If you would like to have more money savings tips like the one you just read be sure to join my mailing list and thanks for reading!