When extreme inflation occurs, it can be tempting to hide your cash under the mattress until it passes. However, hoarding your cash might actually mean you’re losing money rather than keeping it safe.
Real Rate of Return
When you have too much in cash at any time, but especially during times of inflation, you are essentially losing money safely. Who received a 7% return on their CD or savings account last year? How about a 5% return? 3%? No one.
It’s important to remember that one of the points of investing is to keep pace with inflation, if not outpace it. According to Investopedia, “Real rate of return is the annual percentage of profit earned on an investment, adjusted for inflation. Therefore, the real rate of return accurately indicates the actual purchasing power of a given amount of money over time.”
If the interest rate in your account isn’t exceeding inflation, then you are safely losing purchasing power. When you lose purchasing power, your money is worth less.
Here’s an Example
If your return is 8% on an investment and inflation is 5%, then your real return is 3% (8-5=3). If your return is 1% on an investment and inflation is 5%, then your real return is -4% (1-5= -4).
This does not mean that you shouldn’t keep a healthy cash reserve of three to six months’ worth of your expenses. It means that there should be a limit to how much you keep in cash – even during times of inflation.
Stay in Control of Your Finances
During times of inflation – or any time, actually - start with having an adequate cash reserve. Everyone sleeps better at night knowing they’re prepared for emergencies such as a sudden illness or job loss.
We all have the impulse to react when the market changes; understanding those emotions is a big part of successful financial planning. Keep your eye on the long term and remember, you cannot time the market! Stick with your long-term investment strategy and talk to a trusted advisor when you’re feeling uncertain.
Cecilia Beach Brown Is a registered representative offering investment and advisory services through Lincoln Financial Securities Corporation, Member SIPC. Advisory Services are offered to residents of Maryland. LFS and its representatives do not offer tax or legal advice. Please see your tax or legal professional regarding individual circumstances. C Beach Brown, LLC, Pilot Financial Advisors and Lincoln Financial Securities are separate entities. LFS-4296652-020922