Cash vs Stocks & Bonds: Why a Financial Advisor can help you Choose Wisely

Many people are choosing to keep a lot of their money in cash or similar options. These options include CDs or short-term Treasuries and offer good returns and generally are considered safe. While having a well-planned emergency fund is essential, holding excess cash beyond what is needed for emergencies or short-term requirements can be detrimental.

Excessive cash holdings could lead to significantly lower wealth accumulation over time. According to historical data compiled by NYU Stern School of Business, U.S. stocks have outperformed cash in 68% of calendar years since 1928. As CDs and Treasuries mature, reinvesting may be difficult due to lower yields on new investments.

High cash allocations can be exposed to:

• Lower returns

• Inflation risk

• Reinvestment risk

Lower Returns

Bonds carry slightly more risk than cash but generally offer higher returns. Stocks, with their greater volatility, have the potential to generate significantly higher returns compared to cash. The future is uncertain, but having a variety of stocks and bonds can help investors lower risk and reach goals. Over time, the compounded returns from this mix can greatly surpass those from cash alone.

This chart shows the growth of a dollar over the past 30 years, since 1992. If someone put $10,000 into a mix of 60% stocks and 40% bonds, they would have $154,000 now. But if they kept the same amount in cash, they would only have $19,300. Note that at various times cash was yielding over 4% during this period.

When examining bonds specifically, they may sometimes underperform cash in a given year. However, there isn’t a way to know which years it will be.

Historically, over more extended periods, bonds have consistently outperformed cash. For example, in the five years leading up to 2022, cash did better than bonds. But overall, since 1930, bonds have done better than cash in over 80% of five-year periods.

Inflation Risk

The main attraction of holding cash is its perceived safety. Although you won’t lose money in nominal terms, you could lose substantial purchasing power over time. This chart illustrates the eroding effect of inflation on $1 stored away since 1982.

Inflation can reduce wealth more than bear markets, even without factoring in interest earned on cash-like investments. Cash loses value with inflation and increased money supply, unlike assets like equities that can generally appreciate in value.

Reinvestment Risk

Some people believe they can achieve their financial goals by sticking with current cash yields. They may be enticed by higher returns and concerned about inflation. However, a significant consequence to consider is reinvestment risk. The prevailing interest rates on cash-like investments may not remain favorable for long.

Many economists, including Federal Reserve members, predict that short-term interest rates will decrease in 2024. This is especially likely if there is a recession. In that case, rate cuts are expected to happen more quickly.

The chart displays the speed at which the three-month Treasury rate changes. This rate reflects cash yields. It compares how quickly the rate decreases to how rapidly it increases. The data goes back to 1990.

If interest rates decrease significantly, individuals holding a large amount of cash may face a decision whether to accept losses due to inflation or invest in more costly stocks and bonds. Since 1928, stocks have delivered positive returns in 59% of months and 73% of years, presenting daunting odds to bet against.

Bottom Line

The allure of earning approximately 5% with no risk of capital loss is undeniable, yet concealed risks exist. Having a diverse investment portfolio for long-term assets can be better than just relying on cash. It could help you accumulate more wealth in the long run. While increasing cash allocation might offer peace of mind, especially in lower-rate environments, investors should carefully consider the potential ramifications.

Concerns regarding short-term fluctuations in stock or bond markets are understandable. However, history has shown that investors have often been generously rewarded for strategically assuming calculated risks.

Sources:
https://www.empower.com/the-currency/life/three-risks-too-much-cash

Disclosures:

This information is an overview and should not be considered as specific guidance or recommendations for any individual or business.

Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment loss. As with any investment strategy, there is the possibility of profitability as well as loss.

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These are the views of the author, not the named Representative or Advisory Services Network, LLC, and should not be construed as investment advice. Neither the named Representative nor Advisory Services Network, LLC gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your Financial Advisor for further information.