Cash Is King…Or Is It?
The other day, I asked my niece what she wants for her upcoming birthday. She will be turning eight in a few weeks.
I expected her to tell me the name of some toy, whatever is popular with kids nowadays. I can never keep up. But instead, with as much conviction as a seven-year-old can muster, she tells me that she wants money!
I was taken aback. This is the first time she’s ever wanted cash instead of a toy. But then I grinned. It seems that even at seven years of age, she is starting to understand the idea of “cash is king.” Instead of getting a toy from me that she may get bored of in a few weeks, she can get cash, which she can use however she wants to.
Liquidity and Safety
Cash is valuable because it is universally accepted as a medium of exchange. You don’t have to convert it into something else before it’s accepted by the seller. It can be used to buy anything that money can buy.
After all, you could be living in a million-dollar house, but it’s going to take you months to turn that into cash that you could spend on something else. Yes, you may be able to use the house as collateral for a cash loan—that is, if the house has no mortgage or it has enough equity to cover the mortgage loan—but you actually aren’t converting the house itself into cash.
Of course, real estate is an extreme example of an illiquid asset, but the point is that for liquidity purposes, nothing beats cash.
But that liquidity—and safety—comes at a cost.
The Drawback to Cash
Cash on hand earns nothing. Sure, you could put the money in a bank account for essentially no risk. The money is FDIC insured up to $250,000 per bank and generally you can withdraw the money anytime you want, but the bank deposit yields next to nothing. Due to inflation, sitting in cash actually hurts you because the same amount of dollars will buy you less. The higher inflation runs, the more purchasing power you lose.
That’s why it makes sense to invest to put the cash to use. Let your money grow. Although stocks can be volatile, compared to other investment alternatives, I believe they offer an attractive combination of liquidity and growth.
Nowadays, stock trades settle in two business days, so if you sell a stock on a Monday, the cash proceeds from the sale is at your disposal on Wednesday. And it usually takes one business day to transfer the cash from a brokerage account to a checking account. Thus, from beginning to end, it only takes three business days.
Additionally, many stocks also come with a dividend. Most U.S. dividend-paying companies pay a regular dividend every quarter. Some even pay monthly.
Earning Money With Money
The dividend can be reinvested into stocks (e.g. compounding) or used however you want. After all, the dividend income is your money.
Unlike interest from fixed-income instruments like CDs and bonds, a stock dividend typically grows over time. This means that dividend growth can at least partially offset inflation. Since investors also benefit when stock prices rise (capital gains), stocks provide two ways of income growth to combat the inflation monster.
Stocks can fall sometimes, but historically the stock market rises over time. If you have a long enough time horizon and you buy quality stocks, chances are good that you will make money in the stock market.
The upshot is that while cash is king for safety when it come to liquidity and safety, cash is not so great if it’s not put to use. Indeed, cash is so valuable because it can be broadly used to create value, whether through consumption or investment. So put it to use.
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