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Some bank CDs pay more than 5% of APY, and some savings and money market accounts yield close to this number (as of June 2023), making it a good option for investors to invest in retirement savings. No one can be blamed for the temptation to keep a good chunk of the Cash and Cash Equivalents. But if you’re not careful, these high interest rates can erode your retirement money.
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Risk of holding cash
Amy Arnott, Certified Financial Analyst (CFA) and Portfolio Strategist at Morningstar Research Service, maintains a large cash allocation to meet short-term retirement income goals in a year or two I write that it makes sense. Beyond that period, “cash can be particularly detrimental to long-term investment goals, such as retirement.”
Arnott gives the following example: “A retiree who started saving $10,000 a year in 1993 and hid it all in cash will end up with about $380,000 by the end of 2022. Approximately $1.5 million if you invest in a portfolio.” $1 million if you invest in a balanced fund. “
One reason to be wary of cash accounts with high interest rates is that they tend to have higher interest rates during periods of high inflation. In today’s case, rates were pushed higher by the Fed’s decision to raise rates ten times in the last 16 months to curb rising inflation. The Fed raised the benchmark Federal Funds rate from 0.25% in early 2022 to 5.25% in May 2023, remembering inflation was hovering at 8.54% a year when the Fed was launched. It’s important to keep
Now that inflation has dropped to about 4%, bank depositors can make a small profit on high-yield accounts, but it won’t last long. Moreover, as they have for most of the post-pandemic period, banks typically lag behind rates set by the Fed, and real post-inflation gains are short-lived at best. With inflation declining, 1-year CD rates are now higher than 5-year rates, with bankers hoping the Fed will pause or cut rates as the cost of living falls. indicates that
Reasons for holding cash
The reason financial planners advise their clients to invest in the stock market is because it’s nearly impossible to beat long-term inflation with cash. Historically, only stocks have demonstrated the ability to generate post-inflation returns over the long term.
As interest rates fall, cash is likely to return to its traditional role as a financial “parking lot” and return to its status as one of the least-loved types of assets. In other words, it’s a way for investors to stash cash for immediate or short-term needs. However, cash accounts shine when used for the right purposes, such as:
Whether you spend at least three months or over a year, your emergency fund needs to be safe and readily available. CDs, savings and money market accounts are often best suited for this purpose.
The bucket approach to retirement investing separates assets into long-term, medium-term, and short-term buckets according to when the retiree will need the money. Having a year or two of living expenses covered in cash protects against market shocks and allows investors to survive periods of stock price volatility.
It also reduces the series of return risks. This risk arises when poor market performance early in retirement results in losses greater than the portfolio average, making it difficult to continue future retirement withdrawals.
Savings for a home down payment, wedding expenses, or future college tuition payments shouldn’t be kept in stocks. This is especially true if you need that money in the years to come, when a market decline may leave you with less money to invest in stocks.
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Inheritances, lottery winnings, unexpected bonuses, or other unexpected windfalls may be deposited in an FDIC-insured bank CD or money market account. This is a little more intriguing, but it’s up to the recipient to decide how they invest or use their winnings.
Investors who need to hold a certain amount of cash in cash should be able to enjoy temporarily higher interest rates on bank CDs and money market accounts. Remember, cash as an investment is only meant to cover anticipated short-term needs.
- How much cash, bonds, and stocks you keep can be a complex balancing act that varies greatly from tenure to retirement. Your financial advisor will provide the answers on how to structure your holdings. Finding a financial advisor is not difficult. SmartAsset’s free tool matches you with up to three vetted Financial Her Advisors who serve your area. You can also have a free introductory call with an advisor to determine which advisor is right for you. If you’re ready to find an advisor to help you reach your financial goals, start now.
- Fidelity recommends saving 10 times your annual income for retirement by age 67. To see if you’re on track, try SmartAsset’s Retirement Calculator. This will give you an estimate of how much money you will have left over when you retire.
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