Cash In and Wait Out Shifting Markets?
Earning higher returns on cash may be attractive, but investors should stay focused on their long-term financial goals and the asset growth they’ll need to achieve them.
With all the bad news that surfaces seemingly every day, it may surprise some how well markets have been performing lately. Looking back over the fourth quarter of 2022 (and through 4/19/2023), global stocks1 have returned more than 19% and bonds2 have gained approximately 4.4%. We believe that’s quite the run, considering! However, that type of positive performance begs the question: “Are we due for a market dip?” After all, it is possible that the bounce back may be too much, too soon, with storm clouds still lurking on the horizon as we continue to face relatively high inflation, high interest rates and geopolitical turmoil.
As well, cash can appear to be a viable option, given you may get over 4% APY if you allocate wisely. We believe comparing this rate to a few years ago highlights an emotional struggle. Back then, there was the famous acronym “TINA” (There Is No Alternative).3 Essentially, when cash returns were near 0%, if you sold out of bonds or stocks, you knew what you’d get, which was nearly nothing. Getting nearly nothing can lead to impatience and looking for other alternatives, which pushed some investors out of cash and back into stocks or bonds. Today, it’s easier to be convinced to take the 4% and wait for the storm clouds to pass by.
Potential Short-term benefits
For some portion of your dollars, earning about 4% on your liquid assets may be reasonable. Think of any shorter-term cash flows you may have in the next six to 12 months to help support your spending needs. There may also be a big purchase planned in the not-too-distant future. Locking in dollars while getting paid some return can make sense in this environment. Beyond that, however, we believe true investors must think of the longer-term dollars or those targeted to support spending needs for years and decades to come. To meet that objective, we suggest you consider investing for long-term growth.
That’s where data can help inform your investment decisions. While cash yields can be legitimately tempting right now, the Federal Reserve and the markets keep talking more and more about peak interest rates.4 Essentially, when will the Fed stop raising rates (either because inflation is under control and/or a recession or other major issue arises), and perhaps even further, when will they start lowering rates? If they do start lowering, we would anticipate an immediate decline in the rate that cash is paying, which can very quickly make the 4% of today a thing of the past.
Cash vs. bonds
Now, on to some data comparing cash to various bond indexes, and what the return was for the year after CD rates had peaked for particular periods:
Sources: DFA Returns, J.P. Morgan Asset Management. Data above derived from end-of-month start date (e.g., 6/30/1994) through the next 12 months. CD rates prior to 2013 sourced from Federal Reserve, and 2013 to 2023 sourced from Bankrate. CD subsequent 12-month return calculation assumes reinvestment at the prevailing 6-month rate when the initial CD matures. Bloomberg U.S. Treasury Index, Bloomberg U.S. Corporate Bond Index and Bloomberg U.S. Corporate High Yield Indexes used for Treasuries, Investment Grade and High Yield above, respectively.
We believe the data above illustrates a general theme: once interest rates peaked on a 6-month CD, the go-forward return of those CDs versus other bonds was lower. A few notable items:
- In every case shown, the treasury index and investment-grade index (high-quality bonds) performed better than CDs.
- In all but one case (2019), the investment-grade index fared a bit better than the treasury index.
- High-yield bonds didn’t always help generate stronger returns.
Why did all that happen? Well, once interest rates level off or even decline, there is a significantly enhanced probability of bonds doing better than cash.5 In our opinion, investment-grade bonds outperformed treasuries because they carry moderately more risk and, therefore, a little higher yield to compensate for that increased risk, which enhances return. However, high-yield bonds did what we believe high-yields bonds typically do: they added extra return potential (like in 2006) but pushed risk even further, which made it more of a coin flip on whether those types of bonds helped relative to the higher-quality bonds that are noted by the other two categories.
The bottom line
So, what does all this discussion and comparison lead to? We believe cash will continue to be tempting for a while, but don’t believe you should let a yield that’s higher than you’ve seen in a while change your overall investment approach and objectives. Over time, history has shown that bonds often do better than cash6, and stocks often do better than bonds.7 In our opinion, it’s mostly because of risk levels and how the market tends to compensate those who hold risk over time. That’s generally true whether interest rates on cash are 0%, 4% or even 8%. We believe your likely best bet going forward is to be mindful of your “buckets”: How much do you truly need for the shorter term (your cash bucket) versus the longer term (your bucket of stocks and bonds)? Once you’ve identified and quantified your various financial needs, you are in a better position to allocate investments appropriately.
Disclosures:
All indexes are unmanaged. The volatility of indexes could be materially different from that of a client’s portfolio. Index returns do not reflect fees, expenses or sales charges. Index performance is not indicative of the performance of any investment. You cannot invest directly in an index.
The Bloomberg U.S. Corporate High Yield Bond Index measures the USD-denominated, high-yield, fixed-rate corporate bond market.
The Bloomberg Barclays Capital U.S. Aggregate Index represents securities that are SEC-registered, taxable and USD denominated. The index covers the U.S. investment-grade fixed-rate bond market, with index components for government and corporate securities, mortgage pass-through securities and asset-backed securities.
The Bloomberg U.S. Treasury Index measures USD-denominated, fixed-rate, nominal debt issued by the U.S. Treasury. The index has history back to January 1, 1973.
The Bloomberg U.S. Corporate Bond Index measures the investment-grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers.
The MSCI ACWI (All Country World Index) Index measures global equity performance. It is composed of equities from 23 developed markets countries and 24 emerging markets countries, measured in U.S. dollars.
1 MSCI ACWI Total Return
2 Bloomberg U.S. Aggregate Index, reflecting total return
3 https://www.investopedia.com/terms/t/tina-there-no-alternative.asp
4 https://www.bankrate.com/banking/federal-reserve/when-will-the-fed-stop-raising-rates/
5 https://www.usbank.com/investing/financial-perspectives/market-news/interest-rates-affect-bonds.html
6 https://www.investopedia.com/articles/investing/103015/cash-vs-bonds-what-pick-times-uncertainty.asp
7 https://www.forbes.com/advisor/investing/stocks-vs-bonds/
ABOUT THE AUTHOR
Chad Carlson, CFP, CFA
Chad is a Partner, Head of the Central Region. He is based out of our Itasca, IL, office. Previously he was President and served on the Executive Team at legacy firm BDF. In addition, Chad led BDF’s Investment Committee, which oversaw both the strategic and tactical decisions for the firm’s entire investment portfolio. Chad is a frequent speaker and is often quoted in publications such as The Wall Street Journal, Forbes, Investment News, Smart Money and Dow Jones Newswires. Chad has been with BDF since 2005.
