Is Cash the Best Investment?

To rephrase the old saying, telling someone that it's better to have invested and lost than never to have invested at all doesn't offer much comfort. Few things affect the human psyche more than losing money. And if you spend too much time listening to the media, hope is nowhere in sight currently.

Sit still or make a move?
The ultimate question for many investors right now is whether the market has hit bottom. Unfortunately, if you are waiting for the media to give you this news, you're virtually assured of finding out only after the fact. Regardless of whether we've hit the bottom, you don't need to be a rocket scientist to realize that the demand for stocks at this moment is rather weak. And as your high school economics teacher taught you, when demand is low, prices must fall.

So the question becomes, is cash currently the best investment? Are you better off being out of stocks entirely, or is now the time to start dipping your feet in the water? The answer to these questions depends on a host of factors specific to you, such as age and income needs. But in general, for long-term investors, it's worth a look at whether a relatively low-performing asset like cash is currently better than equities.

Look beyond today
With the recent interest rate cuts by the Federal Reserve, the allure of cash has diminished: 2% is a typical return on risk-free instruments such as savings accounts, certificates of deposit, or U.S. Treasury bills. When you consider inflation, cash actually loses value over time. Adding more fuel to the fire is the decline in the dollar.

Nonetheless, having cash at a real rate of return of zero sounds a whole lot better than a 10%, 20%, or even 50% decline in a stock investment. Even the value investors -- who devote efforts to buying businesses for less than intrinsic value -- are experiencing losses today. If you were completely invested in cash at the start of 2008, your rate of return would be killing the broad stock market indexes.

Still, many investors often have it backwards. When interest rates are low and stocks are cheap, there is a flight to the safety of cash. And when rates pick up and the market is fully valued or overvalued, cash is deemed a useless asset that must be put to work. Charlie Munger, vice chairman at Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) and chairman of Wesco Financial (NYSE: WSC  ) stated in his annual report that Wesco purchased more than $800 million worth of marketable securities at the end of 2007. The year before, it reported more than $1 billion of cash equivalents.

For the investor who looks beyond next week, next month, and even next year, the current environment offers an opportunity to put otherwise stagnant cash to work.

Numbers don't lie
The thing is, you don't have to be right about all of your investments to beat cash's low returns. While you might not earn the market's long-term average of 10%, even making half of that would more than double what you can get from cash investments.

In addition, you might make that 5% annual return without having to see share prices rise at all. Dividends can be a very meaningful part of your portfolio returns. Today's turmoil has left some solid companies paying unusually high dividend yields. Bank of America (NYSE: BAC  ) pays 6.6%, Kraft Foods (NYSE: KFT  ) yields 3.5%, Home Depot (NYSE: HD  ) yields 3.2%, and even Wal-Mart (NYSE: WMT  ) pays you a near cash equivalent return dividend of 1.8%. Even if share prices don't budge a penny, many stock dividends leave interest on savings accounts in the dust.

Great businesses + time = profitable returns
Of course, dividend payments can be altered or, as we've seen recently, completely eliminated. One should never make an investment based solely on dividends. But these aren't fly-by-night companies. They're businesses that have been around for decades, weathered many economic storms, and offer products and services that aren't going away anytime soon.

It's always good to have some cash handy. But declining markets are ripe with opportunities for patient investors to prudently put some of that cash to good work. Don't let the risk in the market keep you from making the right investment decisions for your portfolio.

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