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Real Rate of Return: Now’s Not the Time to Hoard Your Cash

Real Rate of Return: Now’s Not the Time to Hoard Your Cash

April 21, 2022
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In a previous blog, we discussed the good and bad news when it comes to inflation. Now, let’s look at what happens to your money if you’re tempted to hold on to cash because you’re feeling uncertain.

When extreme inflation occurs, it can be tempting to hide your money under a mattress until it passes. However, historically hoarding your cash might actually mean you’re losing ground with your goals rather than preserving prior gains.

Understanding Real Rate of Return

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.”

Do you need to keep some cash available? Absolutely. We’ll always recommend you have an easily accessible emergency fund to cover 3-6 months of living expenses. But beyond that, even as you watch the market ebb and flow, now is not the time to cash out.

Why? Because the amount of cash that sits on the sidelines loses purchasing power each year, so it is important to leave only the calculated amount that is needed for emergencies. The longer the funds sit and lose purchasing power, the harder it is going to be to catch up to retirement goals. 

The spread between the inflation rate and an investment’s rate of return is what matters most.  For example, during retirement, most people think that a 6% rate of return is good.  Although that can be true in most years, if the inflation rate is closer to 8% like in our current environment, the retiree has still fallen behind.

This is When it’s Important to Plan

Not having a plan to stay ahead of inflation throughout retirement can cause investors to overfocus on 6-to-12-month periods and ignore the overall success that a portfolio is experiencing. When we work with clients, we’ve already accounted for inflation because we’re helping our clients with the big picture.

We all have the impulse to react when the market changes; understanding those emotions is a big part of successful financial planning. Keeping assets flexible and allocated according to a plan is the best way to avoid panic moves during times of uncertainty. 

And if you’re feeling uncertain, contact your advisor. That’s what we’re here for!