cash is dead

“CASH IS DEAD! CASH IS DEAD! Read All About it.”  In my head, I picture a newsboy from the beginning of the 20th century shouting as I read the article title. The sad reality is that it is true. Cash is dying. No, it isn’t at the hands of cryptocurrencies or apps (Venmo, Facebook, etc.). Cash is dying because the cash in your bank account is LOSING value rather than gaining value. In this article, I will explain this sad phenomenon and provide you with alternative ways to increase the value of your cash.

Why is Cash Dead?

Simply put: Cash is dead because your cash is losing value over time. This realization stemmed from a very frustrating situation. My emergency fund is held in an online, high-yield savings account to maximize interest income. Ally Bank was my online bank of choice for a long-time. After Ally cut my rate. I shifted my emergency to a new savings account at Capital One with a higher, 1.50% interest rate. I was eccstatic to earn more interest. Nearly $100 in fact. Accounts were open, funds were transferred. Quick and easy. Just like that.

Shortly after I opened the accounts in May, Capital One began quietly cutting their interest rate. The rate was lowered from 1.50%, to 1.30%, to 1.15%, and then even to 1.00%. That is a lot of cuts, right? Once the rates were cut to a level below Ally, I transferred the funds back to Ally. Guess what happened next? Within days of my transfer…you guessed it…Ally cut their savings rate as well! Talk about frustrating!!

Naturally, I shared this experience with Lanny. After discussing and sharing our frustrations with interest rates, we both arrived at the same conclusion. What is the point of holding cash if you aren’t earning any interest and it is losing value over time? THIS is why cash is dying.

Cash is dead because your cash is losing value over time.

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Let’s start with interest rates. My frustrating experience stems from the fact that interest rates are once again falling.  The chart below shows the trend in the fed funds rate in 2020. The fed funds rate is one of the benchmark interest rates used by banks and credit unions to set interest rates on their loans and deposit products. Movements in deposit rates will follow movements in the fed funds rates closely. The following chart shows how interest rates have plummetted in 2020.

Not surprising, interest rates fell after the pandemic started. When a tough economic cycle emerges, reducing interest rates is an easy lever for the Fed to pull to spur economic activity. Low interest rates have caused an uptick in lending activity due to a cheaper cost to borrower. It is a great time to buy a house or refinance, in particular, because of the low rates.  This trend is great from borrowers, but terrible for savers.  Like mortgages, the rates on deposits fell. In hindsight, I shouldn’t have been surprised at all that my high yield savings account interest rates were cut at all!

Read: The Impact Interest Rate Cuts Have on Your Portfolio and Mortgage

We have been in a low interest rate environment since the Financial Crisis. As strange as it sounds, in my adult life and during my investing career, I have never experienced a high interest rate environment. The closest I came was when interest rates began to climb in 2018 and 2019, only to reverse course once again. It sure was nice to see Ally adjust my interest rate up during that time.

A low interest rate environment wasn’t always the norm.  The chart above shows the fed funds rate from 1971 – 2020.  Interestingly, a fed funds rate above 5% was common in the past. Imagine how nice that would be right now for our savings accounts.

For me, I graduated college in 2012 and began building my emergency fund right after. Seeing this chart is devastating. However, the low interst rate environment becomes even more devestating when coupled with the other reason our cash is dying…inflation.

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The definition of inflation is the increase in prices and goods over a period of time. Per the Federal Reserve, “inflation is a general increase in the overall price level of the goods and services in the economy.” The Federal Reserve targets an inflation rate between 2%-3% annually and will adjust their monetary policy accordingly to meet this goal.

Due to inflation alone, without any other changes, you should expect your costs to increase 2%-3% annually. Just think about that for a second. In order to cover this additional 2%-3% of costs due to inflation, you must increase the value of your cash by a similar margin. You will be less off financially if you cannot increase your cash by the rate of inflation.

Does anyone else see the problem here? In the last section, I showed how interest rates are decreasing once again.  At the beginning of the article, I shared a story about how the interest rate on my savings accounts were reduced to 1.00%.  Last time I checked, 1.00% is less than 2%-3%.  My cash is losing value in these high-yield savings accounts.

Cash is dead because interest rates have been lower than the target inflation rate for the last decade. 

Will This Change Anytime Soon?

For the forseeable future, nom according to Jerome Powell, Federal Reserve Chairman. In June 2020, during the Fed’s first major economic projection since the start of the pandemic, the Fed stated they does not expect to increase interest rates until 2022.  Without a significant change in economic conditions, it looks like this low interest rate environment is here to stay. Not only is cash down for the count today. It is pinned to the ground for the next several years!

Why You Should Care

If you haven’t figured it out yet, this is a BIG DEAL. You ABSOLUTELY should care that your cash is losing value. Chances are, the interest rate on your checking and savings account is less than inflation. If it is not, please tell what bank or credit union you use in the comments so I can open an account tomorrow.

You should care because over time, your cash loses purchasing power if inflation is greater than your interest rate. I created the following table to demonstrate this over a three year period.  For this example, let’s assume that you place $100 in a savings account at XYZ Bank. The savings account offers a 1% interest rate and inflation is 2% for the next three years. We will also assume the cost of goods purchased is $100. Let’s see the impact.

Interest Rates compared to Inflation

Each year, the gap widens as the impact compounds.  Since you are only earning 1% when costs are increasing 2%, your savings account can no longer cover the cost of goods. You will need to find a way to account for an additional $1 in Year 1, $2.03 in Year 2, or $3.09 in Year 3 to offset the decreasing value of your money.

Obviously, this was a simplistic value with a low dollar amount to demonstrate how your cash is losing value. Now, imagine the following how scary the following scenarios are:

  • Your emergency fund is $10,000, $20,000, or $100,000. The values in the net impact row wouldn’t be so small, would they?
  • Your bank or credit union pays an interest rate of .2%. Suddenly, that net impact in Year 1 increases to -$1.80 instead of -$1.00.
  • Inflation is actually 3% in Year 1 instead of 2% while your interest rate remains the same. The net impact increases to -$2.00 instead of -$1.00.

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Just because cash is dead doesn’t mean there isn’t anything you can do about it! We wouldn’t leave you out high and dry, would we? There are plenty of ways that you can still earn a return that increases the value of your money!

Invest In Dividend Growth stocks

Are you really surprised by this answer?! If you are, you may want to remember the theme of our website! Dividend stocks allow investors to earn a return on their investment in the form of a dividend, in addition to potential appreciation of market value. The average dividend yield of the S&P 500 is around 2%. Thus, if you were to invest in an S&P 500 index fund or ETF, your return would be in line with the broader market.

If, on the other hand, you would like to invest in individual dividend stocks, there is an opportunity to earn a dividend yield above the market. Each of our portfolios’ average dividend yield exceed 3%. This return exceeds the current rate of inflation by a long stretch.

See – The Individual Stocks that Make Up Our Dividend Stock Portfolios 

The one caveat is that investing is not risk-free. Investing the fundsremoves the FDIC insurance protection. However, by carefully considering the companies, investing does not have to be a risky option. Investing in Procter & Gamble, Johnson & Johnson, and Consolidated Edison is a lot different than investing in the hot penny stocks after all.

Watch – Our Top 5 Foundation Dividend Stocks for Your Portfolio 

Our Dividend Stock Screener is designed to identify dividend stocks that have long term track record of paying, and increasing, their dividend.  The screener often identifies companies that are considered Dividend Aristocrats (25+ Consecutive Annual Dividend Increases) and Dividend Kings (50+ Annual Dividend Increases).

Read – Dividend Aristocrats – Who and What Are They? 

Read – Dividend Kings – Who and What Are They? 

The risk of the stock market can never be fully mitigated. However, we try our best to identify and investing in the best dividend growth stocks that will pay a dividend through bull and bear markets. Paying this dividend is key to keeping your cash alive and earning a return greater than the risk of inflation.

Promotional Certificates of Deposits (CDs)

If investing your savings account is too large of a risk for your appetite, there are Certificates of Deposits (CDs). CDs can offer higher interest rates than savings account while maintaining the FDIC insurance protections. Banks and credit unions will pay higher interest rates for a specified period of time (i.e. term). The longer the term of the CD, the higher the inerest rate.

Standard CD rates at an institution may not be that much higher than the rate of inflation. Like savings accounts, their interest rates increase or decrease with the market’s overall interest rate environment. However, banks and credit unions frequently offer promotional CDs at above market interest rates to attract new depositors.  Several months ago, I saw a credit union that offered a 12-month CD for 2.1%.  Does this rate exceed inflation? No. However, this rate does allow you to earn an interest rate in line with inflation.

The trade-off for CDs compared to savings accounts is liquidity. Funds in a savings account are available for withdrawal on demand. Funds in a CD, on the other hand, may be subject to an early withdrawal penalty if you withdraw the funds before maturity. Personally, I would not recommend investing in a CD if the you will need to access the funds before maturity. The potential early withdrawal penalty will offset the bump up in yield you are receiving.

Bank or Credit Union Account Opening Promotions

Banks and Credits also offer cash bonuses to open accounts at their institution. For example, in the mail today, I received an offer from Chase Bank. I would receive $200 for openinga new account and deposited a certain sum of money over.  Offers like these are common practice in an attempt to lure consumers, similar to the promotional CDs.

Let’s have some fun here. In order to earn at least 2% yield in line with inflation. I would have had to deposit $10,000 or less at Chase. If the bonus offer required more, your yield would be less than 2% and you would still lose purchasing power on your cash.

Luckily, if you are interested in pursuing this hack, most offers are for an amount less than $10,000. Last year, I opened two accounts solely to earn the bonus. The returns were just too strong to ignore.  One promotion was gave me $600 for depositing $2,000 at a bank and the one promotion gave me $400 for depositing $500 at a bank. Overall, that was a 39.9% return on my money. That is how you keep your cash alive!

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I hate to sound all doom and gloom in the article.  As long as we are in a low interest rate environment your cash is dead. It just doesn’t make sense to hold large cash balances in an account that is losing value over time. A very sad and unfortunate reality. Hopefully this article shed some light on the topic and showed you a few ways to earn more on your cash, reverse the trend, and revive your cash balance!

Do you agree with my conclusion about cash being dead? How do you manage your cash balance? Do you invest in dividend growth stocks to earn more on your cash? Do you account hack and open promotional accounts to earn the bonuses?

Bert

Image Source: Interest Rate Charts

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