Money in a bank account isn’t earning much these days. Interest rates on savings accounts are somewhere between 0% and 0.5%. The days of a CD at the bank paying 8% are a distant memory. Even then, 8% probably wasn’t as good as you may think. Cash can only maintain its value if rising prices do not erode purchasing power. In fact, cash has barely outpaced inflation since 1926. History suggests that today’s low return prospects for cash are not all that different from the returns of the past century.
Treasury Bills, which are good proxies for the returns on cash in a savings account or money market fund, earned an annual average of 3.3% per year since 1926. Over the same period, inflation grew at annual 2.9% rate, resulting in an inflation-adjusted 0.4% average return for cash.
There was considerable variability over these 94 years. Cash significantly beat inflation only twice – from the late 1920s to mid-1930s and the 1980s to early 2000s. Cash performed extremely well relative to inflation in the 20s and 30s because prices of goods fell a stunning 30%. In the 1980s, Fed Chair Paul Volcker raised interest rates to stamp out troubling high inflation (kicking off a recession too). That kicked off a golden era for high interest rates and falling inflation that lasted until the recession hit in 2000.
But only in hindsight was a Treasury Bill yielding 8% in the 80s such a great deal. It wasn’t at all clear that inflation would continue to march lower. A Bill paying 8% would not maintain its value if inflation jumped back to 10% as it had in recent past. Luckily, it worked out just fine as inflation steadily crept lower for the next two decades.
In other periods, savers holding cash have not been as fortunate. The late 30s and 40s saw tremendous swings in inflation as wartime efforts constrained production and the government attempted to contain inflation with price controls. The Federal Reserve also pinned interest rates low to help finance the war deficit.
More recently, the Federal Reserve has kept interest rates low after the 2008-09 recession to help the economic recovery. The result was an erosion of purchasing power of cash, although nothing like the scale seen in the WWII era.
Today, the Federal Reserve has made it clear that they will allow inflation to run ahead of their inflation target of 2% for some period of time before tightening policy and hiking short-term rates. It is also possible that pandemic-constrained supply chains could result in shortages of certain items, pushing up prices.
Recently, cryptocurrency has been pitched as a replacement to modern fiat cash. But like gold, it has no financial claim and does not pay interest. The ability of cryptocurrency or precious metals to be a store or value depends solely on someone else willing to pay you a higher price. They also fail miserably at being stable enough to reliably exchange for goods.
We all need some amount of cash to live. Cash provides liquidity and stability to buy the things we need in a reasonably short time frame. But holding cash has not proven to be a good long-term investment strategy. For many, it is the anti-investment – what investors want when stocks and bonds look too scary. But that safety has historically carried a cost and will likely continue to do so.
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