Rule 2: Interest earned on cash is less than inflation.
When inflation rates dropped below 4%, such as was the case in November 13, 2023 when it fell to 3.14%, money market rates still hovered north of 5%. This paints a curious picture for savers: at first glance, it seems like a straightforward win – your savings in a money market account could potentially beat inflation by a margin greater than 1%. This gap might appear like a financial buffer, aiding in managing debts and expenses. For those influenced by the recent trends, and those with shorter time horizons, this might even seem like a standard financial environment.
However, when we step back and look at a broader timeframe, the story changes. Over a five-year period from October 16, 2018, to October 16, 2023, inflation averaged around 4.00%, while money market rates typically hovered at about 2.00%. Instead of sprinting ahead, money markets were actually trailing behind inflation during this period. Clients who were in money market funds were searching for higher yields. Inflation was eroding their savings. Periods like we have seen, and like we are experiencing now, do not last forever.
This brings us to a critical question: what does it really cost to sit on the sidelines in cash, especially when your goal is to grow your capital? Particularly over longer periods? The recent data reveals a somewhat uncomfortable truth. The concept of ‘capital preservation’ through traditional safe havens like money market accounts may not be what it appears during periods of high inflation. While the fear of market fluctuations often drives investors towards these ‘safer’ options, the reality, highlighted by the numbers, tells a tale of potential financial stagnation or decline, especially when set against the backdrop of ongoing inflation.
The contrast between the current scenario and the historical average underscores a vital point. Opting for the perceived safety of money market accounts can carry the hidden cost of diminishing purchasing power over time. It highlights the need for a diversified investment strategy that not only seeks to preserve capital but also to outpace inflation, ensuring that your financial growth isn’t just a mirage in the desert of the current economic climate.