Your cash today will have a smaller value in the future if you don’t guard against inflation.
It pays to save and keep some money for the future — you’ll be prepared and won’t need to borrow when unexpected emergencies come up, and you’ll have enough to make that long-awaited purchase for a car or a similar asset you’ve long desired.
But while it is good to have cash available at all times, it is not wise to hold very large deposits. Experts say doing so is a misapplication of resources.
When cash is not king
To most businessmen, cash is king but even the most successful of them do not maintain very large deposits of cash. Most likely, their wealth will be spread out in various assets, from stocks to bonds, mutual funds, real estate, and finally, cash deposits at a smaller percentage compared to the other asset classes. Here are at least two reasons why their cash deposits are not that substantial:
1. Cash does not give as much returns as other investments.
Interest rates on cash deposits are lower than that which you may potentially earn through mutual funds, bonds, stocks, and even real estate.
Just look at savings accounts. Most banks offer one to three percent interest on savings accounts. Time deposits may give you five to seven percent yield. But the same amount of money may earn you more than seven percent in the other asset classes depending on market conditions and the length of time you hold the investment.
It would be wise then, to allot a small percentage of your wealth to cash deposits, then put the bulk of your money in other forms of investments.
2. Inflation reduces the buying power of cash.
Put simply, inflation is the general increase in prices. We have seen prices of commodities and everything else rising over the years. A thousand pesos ten years ago could buy more items then than a thousand pesos these days.
When the inflation rate is high, the buying power of cash erodes and interest rates for loans remain high.
According to The Citibank Guide to Building Personal Wealth, “Unlike cash, investments such as equities and real estate tend to beat inflation by a substantial margin over the long term.” Diversify your investments to offset the effects of inflation. A good rule to observe is to go for investments that may potentially offer rates higher than the current inflation rate.
However, do remember that unlike deposits, with investments there is the possibility you could lose your principal so it is best to study the markets before jumping in, understand the risks involved and choose the alternative that suits you.
How much cash to keep
The amount of cash you need to maintain depends on your circumstances and attitude. You can keep enough cash to cover your normal expenses for three months to a year plus a lump sum to pay for emergencies.
You can also keep cash to a specific percentage in relation to your total investments. In the US, keeping cash to five to 10 percent of total assets is considered appropriate. In Asia and the Pacific, the rate may be higher. But experts say that if you keep more than 10 percent of your total assets in cash, it’s time to reconsider if you really need that much amount.
This is because other forms of investments are also readily accessible. Stocks, bonds, and shares in mutual funds can easily be sold and turned to cash as the need arises.
Where to put your cash
Banks offer a convenient and secure location for your cash. When choosing a bank, look for stability and credible reputation and one whose products are relevant to your needs and gives you easy access to your funds, such as 24-hour customer hotline and online banking.
Scout around for the best interest rates. Generally, the longer time you lock up the cash in the bank, the higher rate you will get.
Ask banks for their time deposit rates and consider new product offerings such as a time deposit that would allow you to withdraw cash prior to maturity date without penalty. Before deciding on what bank to transact with, do your research.
In place of peso deposits, you may also hold foreign currency deposits. Banks now have accounts offered in US dollars, euro and even yen. Some banks also offer free insurance coverage tied to your maintaining deposit balance. Apart from peso-denominated insurance for peso deposits, some banks also offer free dollar-denominated insurance for clients with qualifying dollar deposits. Keep in mind, however, that foreign exchange rates fluctuate.
Money market placements are also considered cash investments. Your money will be invested in short-term debt or government instruments. Again, scout around for the best rates.
Wise wealth building
As you can see, building wealth should not just mean building up cash reserves in the bank. The trick is to save smarter, not just harder by safeguarding your cash — keep it to a minimum, go for higher rates, and choose your bank well. Diversify your investments and you’ll see better returns in the long run.
– From the “Take Charge of Your Money” series published on http://business.inq7.net/money/.
Tags: save wisely, saving tips, money saving tips, how to save money, wealth management, financial planning, financial plan, financial freedom, citibank, inquirer, philippine daily inquirer, take charge of your money, personal finance