- First, the safety of cash begins to look suspect if you're losing the true value of your money - the ability to buy the things you need - because of inflation.
- Second, since the yield is so low, the income generated by cash is not sufficient to buy the goods and services you need, which will force you to liquidate your principal.
- Finally, the false illusion of safety is compounded because the low yield on cash is further reduced by taxes. Worst yet, you will pay tax at your highest marginal rate. Unfortunately the combination of a high tax rate and a low yield only increase your need to liquidate assets.
1982-2002 (20 years) Average inflation rate 3.36%
1992-2002 (10 years) Average inflation rate 2.75%
2. Your living costs are rising, and you forgot to factor in inflation. If inflation averages just 3% for the first year, your annual expenses would increase by an additional $1,080, compounding your income need. After only the first year, you would have to start liquidating principal to buy the same goods, and services you enjoyed the year before.
Safe but Sorry
Over the years we have seen many people make the same big mistake - they opt for the safety of principal that cash investments offer and ignore inflation risk. Inflation robs them of the purchasing power of cash; this illusion of safety would cost dearly. When interest rates drop, they maybe forced to dip into their original capital. The more principal taken out, the less income will be produced putting them on a slippery slope.
The classic problems of:
- low yield,
- high taxes and
- no inflation protection
Bonds start out with a little more income for each dollar invested, but suffer the same defects that cash investments do. And, although it may not be widely understood by most investors, bonds can also suffer from high volatility and risk under the right circumstances.
Is there another option to meet your income needs without impairing the capital base? We shall take a look at the difference dividend paying stocks can make. As an investor in dividend-paying stocks, you not only get to keep more of what you earn from dividends becasue of lower taxes, but it's likely your dividend income and value will increase over time to keep you with inflation. These exciting fundamental benefits are also available in dividend-paying stocks for growth.