Heading into 2022, both the stock market and bond market were trading at lofty valuations. It's hard to put your hard-earned cash on the line when investments are so expensive, and many investors may be wondering if stashing cash somewhere might be a good alternative.
The first week of 2022 wasn't kind to investors, and it may have scared some of them to build up more cash reserves. But cash may not be the best place to put your money in 2022.
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The inflation headwind
It's hard not to talk about the value of cash these days without talking about inflation. The consumer price index -- a measure of the average change in the prices paid by consumers -- increased 6.8% in November. It's also showing strong month-over-month growth, up 0.8% from October. So investors shouldn't expect inflation rates to come back to pre-pandemic levels anytime soon.
Meanwhile, holding cash in a savings account is unlikely to produce any nominal return. The average savings account offers 0.06% interest. That's because the overnight rate from the Federal Reserve remains low. While the Fed may be increasing the rate in 2022, investors shouldn't expect a meaningful bump in savings-account interest rates because they remained low during the Fed's last series of rate increases at the end of the last decade.
In other words, you're practically guaranteeing a loss of value if you hold cash in 2022. The question is whether that guaranteed loss is better than other investment options.
Is it worth the risk?
Market valuations are certainly very high. The Cyclically Adjusted P/E (CAPE) ratio -- a historical measure of market valuations based on the price-to-earnings ratio -- hasn't been this high since the dot-com bubble. And it was never this high before that.
But you can't look at stock valuations in a vacuum. Treasury bonds are also yielding near historic lows. That means the risk-free rate of return is very low, and investors should, therefore, be willing to accept lower returns from stocks and thus, higher stock prices.
At the very least, investors should have lower expected returns for stocks and bonds on a long-term basis. That could come from slow-and-steady growth or an imminent crash and return to historical growth rates thereafter. It's impossible to say with any certainty.
If you're planning to invest for the long run, you'll in all likelihood end up with a more valuable portfolio by investing in stocks in 2022 than holding cash over the next decade-plus. Still, you may feel uneasy investing your money knowing there's a potential for a stock market crash.
What are the alternatives?
There are some alternatives you could look at in order to grow the value of your money.
One option is to invest in Series I Savings Bonds. Series I bond rates are adjusted every six months based on prevailing interest rates. The real interest rate comes out to be about 0%, but your money's protected from inflation.
The drawback of I bonds is that each person can only invest $10,000 in I bonds per year when investing electronically. You may be able to invest up to $5,000 more by overpaying your taxes and using the refund to purchase paper I bonds. Additionally, it requires you to lock up your money for at least a year, and there's a penalty of three months worth of interest if you withdraw funds within five years.
You could dive into the complex world of decentralized finance (DeFi) and do things like use stablecoins to yield farm (where you lend out your cryptocurrency holdings and earn interest on it) paired with existing cryptocurrency investments. Going this route can find you attractive yields outpacing inflation. Alternatively, you could simply deposit a stablecoin with one of the popular exchanges or DeFi apps to earn high interest rates on your savings. While those interest rates are backed by overcollateralized loans, there's still significant risk in that sort of investment.
Investor takeaway
There are a lot of better choices than holding cash in 2022. Inflation will deteriorate the value of your savings if you decide to stash your cash in a bank account. Over the long run, you'll be better off investing now, even if expected returns are lower than they've been historically. Alternatively, you can invest in more stable savings options like those above and still beat inflation.
