Cash Yields and Investing: 4 Key ConsiderationsOctober 20, 2023
Considering moving to cash while interest rates are high? There are four key things you should think about before taking action…we explore here.
A growing number of investors are deliberating selling investments and increasing their cash balances to take advantage of elevated interest rates, and to avoid the exhausting volatility of the markets. While we acknowledge that higher interest rates may make cash accounts the most attractive they have been in years, we maintain that they are inferior to a diversified investment portfolio for a long-term investor.
4 key considerations:
1. Short-term interest rates are expected to decline.
Today’s interest rates may not last, and, therefore, they may not be a good estimate of cash’s long-term return potential. The Federal Reserve was a major driving force behind the dramatic increase in short-term US interest rates; when it increased its target rate to tame inflation, many other market yields rose in tandem. At present, inflation has significantly receded1, and forward-looking metrics suggest reduced target rates (“easing”) are more likely than increased target rates (“hiking”)2.
2. Bond funds offer the potential for higher returns and diversification.
Converting bond funds into cash may adversely affect the return/risk profile of a portfolio. First, many bond market sectors offer yields that surpass those of cash3,4. Second, although bonds have greater volatility than cash, certain bond funds have the potential to diversify stock risk in a portfolio – to potentially appreciate if stocks decline. While this behavior has been less consistent in the last two years, it was extremely valuable in other turbulent markets, such as 20085. Lastly, the after-tax returns of cash may be inferior to municipal bond funds, depending on investor tax characteristics.
3. Cash yields are not competitive with stock returns.
Interest rates are the highest in several years, but average stock returns may outperform cash in the long run. For example, the S&P 500, a leading US stock index, has outpaced cash equivalents, represented by the Bloomberg US Treasury Bills Index, in most five-year periods since February 19896. Interestingly, stock outperformance was greatest in the mid-1990’s, when the Federal Reserve target rate was close to today’s level6,7.
Moreover, moving frequently between cash and stocks risks the hazards of “market timing.” Evidence suggests that acting on short-term predictions reduces average returns8. The difficulty is two-fold: knowing when to trade, and knowing when to trade back. The best and worst performing days in the stock market often happen close together, making it difficult to identify suitable entry and exit points9.
4. Cash is not personalized.
Cash accounts are not individually crafted and updated. The optimal portfolio for your financial plan may involve a mix of investments that maximize your chance of success given your unique circumstances. Different investors may have different exposures: to inflation, in particular. For this reason, we believe personalization can add meaningful value.
Interested in discussing the markets and your portfolio? Contact us, we’re here to help.
1 U.S. Bureau of Labor Statistics, CPI
2 CME FedWatch Tool, as of 10/13/2023
4 Eaton Vance: Monthly Market Monitor, October 2023
5 MFS: Asset Allocation Diversification – 20 Years of the Best and Worst
6 Morningstar: 2/1/1989 – 9/30/2023, 5 year rolling window, 1 month rolling step, S&P 500 TR USD, Bloomberg US Treasury Bills TR USD
7 FRED Economic Data, Federal Funds Effective Rate
8 Morningstar: Bad Timing Cost Investors One Fifth of Their Funds’ Returns
9 Vanguard: Why to Focus on Long-Term Market Results
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not consider any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. This communication may contain certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Generally, among asset classes, stocks are more volatile than bonds or short-term instruments. Government bonds and corporate bonds have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns. U.S. Treasury Bills maintain a stable value if held to maturity, but returns are generally only slightly above the inflation rate.
Diversification does not ensure a profit or guarantee against loss.
KLR Investment Advisors LLC (“KLRIA”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where KLR Investment and its representatives are properly licensed or exempt from licensure.