1 in 4 Americans Are Making a Big Financial Mistake

By Markets Fool.com

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According to a recent survey by Bankrate.com, nearly one-quarter of Americans think cash is the best option for a long-term investment. Even more surprising, less than one in six said stocks are the way to go. Here's why cash isn't the way to go, and what the majority of people should be doing with their investment dollars.

What Americans think the best investment is

A recent Bankrate.com survey asked Americans to select the best way to invest money they wouldn't need for 10 years or more, and the results are quite alarming. Real estate was the most frequent answer, given by 25% of those surveyed, and cash was the second most popular response. Surprisingly, stock investments were chosen by just 16%.

Investment Type

Respondents

Real estate

25%

Cash and equivalent investments

23%

Precious metals

16%

Stocks

16%

Bonds

5%

Don't know/No answer

9%

Data source: Bankrate Financial Security Index survey, July 19, 2016.

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Now, some of the other choices do make good financial sense. Real estate -- in the form of investment properties, not your primary home -- can be a fantastic way to get both income and growth. In fact, I'm a real estate investor myself and many of my favorite stocks are real estate investment trusts (REITs). And bonds can be a good way to generate income with little downside risk.

But I'm not a fan of precious metals as a primary investment; they don't generate income or perform any other function, rather, their value is simply based on what someone else is willing to pay for it. However, precious metals should at least do a better job of keeping up with inflation than cash.

Frankly, I was surprised at how many people said cash was the best investment to use for money that isn't needed anytime soon. Younger generations were even more vocal about their love for cash: 32% of millennials chose cash as their top choice, including 43% of those under 25.

Let me be clear before going further -- I'm not bashing cash and savings accounts in general. It's a great idea to keep a substantial amount of cash in a readily accessible place like a savings account to help cover unforeseen expenses or get you through difficult financial times. However, it's a terrible investment for say, your retirement savings.

Why cash is a bad idea

It's easy to understand why many investors (especially the younger ones) are afraid of the stock market. After all, their teenage years and adult lives have been scarred by the dot-com bubble and the financial crisis. However, over long time periods, stocks have outperformed all other types of assets, again and again. As a recent example, over the past 30 years, the market has gained an average of 7.3% per year, including the two crashes I mentioned plus Black Monday in 1987. When adding in dividends, the total return has been an annualized 9.5%.

Data by YCharts.

On the other hand, cash investments produce terrible investment returns. This is especially true in the current low-interest environment. According to the FDIC, the average savings account pays a paltry 0.06% interest rate, and even a five-year CD pays just 0.78%.

Cash or Equivalent Investment

Average Interest Rate

Savings account

0.06%

Money market

0.08%

6-month CD

0.13%

1-year CD

0.22%

5-year CD

0.78%

Data source: FDIC (Rates as of July, 25,2016).

Not only will your money not grow much, but you'll actually lose value over time, thanks to inflation. Depending on what time period you use and what index you're looking at, inflation has historically averaged about 3% per year. So, by sticking your money in a savings account, you can expect to lose 2.94% per year.

Stocks or bonds are best

The main problem is that many people automatically equate the words "stocks" and "bonds" with the word "risk." While it's true that stocks and even bonds can be volatile, there's many levels of risk within those two categories.

For example, even the most risk-adverse investors could put their money into 10-year Treasury bonds, which currently yield about 1.6%. Still not great, but certainly better than a savings account. Or, invest in only the most established and rock-solid stocks. You can even buy a mutual fund that spreads your money around many companies in order to reduce your risk.

The bottom line is that all of most investors' portfolios should be in stocks and bonds, with younger investors taking a more stock-oriented approach and older investors shifting their allocation toward bonds.

To be clear, if you invest in stocks and bonds, the value of your portfolio will certainly fluctuate over time. You may even have times when your portfolio drops by 10% or more in a matter of weeks. However, since you don't need the money for 10 years or more, short-term volatility should not prevent you from taking advantage of the stock market's amazing long-term compounding power.

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