Investors are sitting on wads of cash just at the wrong time

The latest consumer inflation rate was clocked at 2.3 percent in April. Sounds pretty benign, doesn’t it? Well it isn’t if you are keeping large sums of money in the bank at today’s interest rates.

In fact, “safe” money in the bank is being subject to erosion just as surely as any stock market decline might affect your investment portfolio. As any saver knows, interest rates on bank deposits, money market mutual funds, and short-term U.S. Treasury Bills are miserable, hovering close to zero. And the Federal Reserve Board, which manipulates short-term interest rates in order to achieve its dual mandate of low inflation and full employment, has vowed to keep rates at current levels into the year 2014.

But scared investors are sitting on a ton of cash, even as they worry about the threat of inflation, found a survey done for MFS Investment Management. The average investor has 26 percent of his or her portfolio in cash because they are scared to invest in a volatile market environment. The cost of that perceived safety is a decline in purchasing power. As each day passes and inflation rises, money held at the bank will purchase fewer goods and services. Although everyone should keep a cash store in a safe place for emergencies, it is detrimental to your wealth to hold excess cash these days.

Savers have two good alternatives. One is to use some of the excess cash to pay down debt. Almost any loan today, from a mortgage to a credit card balance, is charging more interest than you are making at the bank. The second alternative is to invest some of the cash into a diversified portfolio that includes stocks and bonds. Yes, you will have to bear market volatility, but higher rates on bonds and capital appreciation on stocks will give you a fighting chance to beat inflation.