Despite inflation, it’s a good time to increase your cash reserve

Here are some controversial financial tips for today’s times: Keep more cash.

It is not the same as “go to cash”, which would be a call to exit the market. Far from there.

And it’s not advice most people are comfortable giving right now, given the current economic conditions. On Tuesday, the US Department of Labor released the latest Consumer Price Index figures, showing an inflation rate of 8.5% last month, the fastest 12-month pace of price increases since nineteen eighty one.

Holding cash hardly sounds like a winning strategy when every dollar you set aside today will likely have less than 95 cents of purchasing power a year from now.

But if consumers, savers and investors have learned anything from the financial fallout of the pandemic, it’s the value of an emergency fund, and while current inflationary pressures are not at all the same type crisis than a loss of job or a potential work stoppage, they present a serious problem, especially for anyone who lives actively from their investments.

As someone who has said in recent columns not to let higher prices scare you away and to remind you that they won’t break you down or force you into a comfortable retirement, that’s no volte -face or a change in tone.

In fact, my thoughts here tie into another recent column about how these volatile and uncertain times are making investors lean into risk, diversifying so they get a bit of everything in their portfolio.

By holding more cash, however, investors diversify and protect the timing of their investments, leaving long- and medium-term holdings in place and covering short-term spending needs despite low greenback yields.

The standard investment advice people get in times of volatility is to buckle up and ride out. This remains the best course of action – perhaps with some minor adjustments to the portfolio – and the plan for anyone who can hold steady through short-term action on the path to achieving their long-term goals.

The problem is that staying put and breaking the deadlock becomes more difficult as stock and bond markets become volatile and unpredictable.

So let’s look at the current situation, with inflation at levels last seen more than 40 years ago and interest rates rising and threatening to rise considerably higher.

In times of inflation, the bond market’s natural reaction is to raise interest rates, which drives down bond prices and the value of bond funds. At the same time, inflationary environments also put downward pressure on stock prices.

This means that a standard investment mix of, say, 60% stocks and 40% bonds could see both sides losing money at the same time.

It’s a waste of paper and no problem, until you need to make a withdrawal.

If you need to withdraw 4% or 5% of your money at a time when the account value is falling, your investment statements will reflect declines above those of the market.

When the market loses a penny and you take off another nickel, your losses on paper look like big dollars.

This is when people panic and mess things up.

“If you’re in a position where you need to make withdrawals, you might really want to have cash – however little you get – just because it’s not going down,” said John Waggoner, for a long time. personal finance journalist and AARP.org financial editor, in an interview this week on “Money Life with Chuck Jaffe.” “Having cash on hand that won’t go down when everything else is is a good idea.”

Yes, it’s even a good idea if that money is losing purchasing power due to inflation each month it’s set aside.

Sophisticated investors will consider the short term of their needs – there’s a big difference between the money you might need tomorrow and the money you might need in the short term over the next few years – and plan of match around that.

For example, one of the best single buys right now is the US Inflation-Protected Savings Bond (I Bonds), which currently pays 7.12% and is expected to pay north of 8% when the rate will adjust in May.

This is a long-term investment that you can reallocate to your own needs, but it will not replace a money market fund as a parking place for cash with immediate needs, as I-bonds must be held for at least one year; collecting them during the first five years entails the loss of three months’ interest.

Yet for someone who has money in the money market account to cover immediate emergencies – but fears that inflation will remain at current/near levels until 2023 or beyond – an I- bond can be an ideal parking spot, yielding a better return than bank accounts and cash funds even after paying the short-term withdrawal penalty.

This is an extension of the lesson many investors learned the hard way during the pandemic, when having an emergency fund and cash reserve was essential to minimize or avoid much of pain.

It is also equally personal/individual, in that this advice is not unique. Young investors tend to think time will heal all wounds – and they may be right – but if they’re planning to cash in on investments to buy a home in a few years, at least some of their money can’t. not just “take it away”. “Similarly, seniors who meet their income needs with a steady stream of dividends or with annuities and other cash-generating securities might not have much reason to access additional short-term cash.

But for anyone who feels the need to be on the defensive, it’s hard to resist having a little more cash on hand now.

And for those who want to quibble about how that money is losing ground to inflation, consider that small shortfall in the cost of insuring against the exploitation of long-lived assets at the wrong time in the event of a emergency.

If it helps you sleep better at night, it’s worth it.

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