I bet you’ve heard the phrase “cash is king” a thousand times in the investment world… (maybe even from friends and family) but, is this true? Is cash really the best thing to hold in today’s world? I can tell you why it may not be. It has a lot to do with this ONE WORD…
Inflation.
Yep… Inflation.
Probably the most heinous tax of them all… And, yes it is a tax paid for by you and supported by governments and central banks the world over. Why? Well, because they can promise you more “free” stuff and be out of office before the effects are felt by future generations.
But I digress.
What is inflation… It’s simply an increase in the supply of currency in an economy. When more currency is injected into the economy we end up with more paper dollars chasing the same number of goods which ultimately causes prices to rise. Understand… rising prices are the result of inflationary policies, not the cause of inflation.
At this time, governments around the world are engaged in inflationary policies like the world has never seen due to all the economic trouble that hit many countries back in 2007 and 2008 when the derivative markets got hammered. Cash was injected into the markets to prevent massive losses by the big banks under the guise of this being “good for the people”. In reality, this was good for banks and allowed them to remain solvent.
The net effect being that more cash (in the form of ledger entries on bank balance sheets) has found it’s way into the world’s major economies. Of course, this doesn’t happen overnight… It takes time to work its way into the hands of the average person and impact prices.
Inflation is so common that governments and central banks have press conferences and tell us the current rates of inflation.
The inflation rates in North America are generally publicly announced as being between 2% and 4% annually. This mean that any cash you save loses it’s purchasing power at the rate of inflation annually!
Say you have have $1,000 in savings on January 1st and the bank pays you .05% interest yearly, for example. Then, on December 31st your $1,000 dollars would have earned $5 in interest bringing your account balance to $1,005… OK, you got $5 bucks for free, right? Well, not really… If the inflation rate was 2% for the year, the actual spending power of your $1,000 has been reduced by 2% or $20 in this case. So the bank paid you $5 in interest but the government and central bank took $20 from you in purchasing power… leaving you a net real loss of $15 dollars!
Inflation is the reason a new Camaro cost $3,500 in 1970 and $35,000 today… It’s why comic books cost $0.55 in 1970 and $3.99 today… And, even more sinister: it’s why retirees on a fixed income get poorer every year as the checks they cash by less and less.
So, do you want to retire poor? No? Then, you better get started buying assets that produce cash flow. The reason cash is not king is that it’s purchasing power is constantly being eroded by those you elect. But, the good news is that CASH FLOW is inflation resistant! Buying assets that pay you ensure your payments go up as inflationary policies pump more currency into the economy.
As rents, royalties, dividends, and loan payments generally trend with inflation, buying these types of revenue streams generally provide solid protection of your returns and therefore your standard of living by rising with inflation as oppose to being victim of it.
