Holding too much cash could damage your chances of retiring early. Certainly, having some cash for emergencies such as challenging employment periods is a good idea, but relying on cash savings to produce a nest egg for retirement could reduce your chances of retiring early when compared to holding dividend stocks.
Dividend-paying stocks offer higher returns than cash over the long run, while their returns are likely to be significantly above inflation. As such, now could be the right time to buy them in order to allow compounding to fully impact returns over the long term.
With interest rates continuing to be low versus their historic levels, the returns on cash savings are generally low. Furthermore, the prospect of interest rates returning to higher levels that are in line with their historic averages is uncertain, since a challenging near-term outlook for the global economy could cause policymakers to maintain loose monetary policies in the medium term.
This may mean that cash savings deliver a return which is lower than inflation. Although this may not cause an obvious loss of spending power in the short term, it may mean that the size of your retirement nest egg is insufficient to provide a generous passive income in older age.
High return prospects
By contrast, investing in companies that pay dividends could lead to significantly higher returns. The track record of the stock market shows that while bear markets occur on a regular basis, they are only temporary. As such, investing in a range of stocks and holding them through a variety of market conditions has historically been a sound means of generating a retirement fund from which to draw an income on older age.
Moreover, dividend-paying stocks could deliver higher returns than the wider stock market. They could prove to be popular among a range of investors at a time when other assets lack income potential and the world economy faces an uncertain period. Since many stocks with generous dividend payouts are mature businesses that have long track records of robust shareholder payouts, they could offer defensive qualities that appeal to investors during what may prove to be a volatile period for the global economy.
Of course, over the long term the difference in returns between dividend stocks and cash is likely to widen. The impact of compounding can take many years to become significant, but the reinvestment of dividends could improve your chances of retiring early. Therefore, avoiding the temptation to spend dividends received prior to retirement could be a key hurdle to overcome for any investor who is seeking to retire early.
Looking ahead, there may be periods of time where cash seems to be a more favourable investment option compared to holding dividend stocks. However, history shows that investing, rather than saving, surplus cash is likely to be a more effective means of bringing your retirement date a step closer.
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