As the Federal Reserve raised its benchmark interest rate to levels not seen in two decades, savers and risk-averse cash investors rejoiced. With the central bank maintaining a target range of 5.25% to 5.50% since July, cash became the go-to investment choice, attracting individuals to bank certificates of deposit, high-yield savings accounts, money-market mutual funds, and short-term Treasury debt. Yields exceeding 5% were easily attainable, making cash the “cool kid” in the financial arena.
However, a recent data analysis has cast doubt on the long-term profitability of cash investments. Callie Cox, a US investment analyst at eToro, discovered that the returns generated by cash during high-rate periods fail to match the potential gains from stocks that usually follow these periods. The disparity is significant.
Cox meticulously examined economic cycles dating back to 1961, defining each cycle as the end of one recession and the start of another. Firstly, she identified the highest yield on a 1-year Treasury note within each cycle, using it as a proxy for cash returns. Next, she analyzed the top one-day performance of the S&P 500 following the date of that highest yield, measuring it year over year. Here are her findings:
- Despite the allure of 5% cash investments currently, Cox’s analysis highlights the need for everyday investors heavily reliant on cash to consider increasing their stock exposure.
- She cautions against being too comfortable with cash, describing it as a “warm fuzzy blanket.” While attractive in uncertain times, taking on some risk may prove beneficial.
It is worth noting that after a challenging 2022, the S&P 500 has displayed impressive performance. With a year-over-year increase of nearly 12% and a year-to-date surge of almost 19%, stocks have proven their potential for growth.
In summary, as interest rates rise and cash investments become increasingly appealing, it is essential for investors to recognize the potential advantages of shifting toward stocks. While cash may offer comfort and stability, the historical data suggests that embracing a degree of risk through stock exposure might yield greater rewards in the long run.
Stocks Rally on Expectations of Rate Cuts
Investors are driving the stock market higher in November, fuelled by the anticipation of upcoming interest rate cuts. This positive sentiment comes as cash investments, which currently offer historically attractive 5% yields, are expected to undergo changes in returns.
While cash investments are important for certain situations such as individual risk tolerance, purchasing large items, or temporarily parking funds before deciding on future investments, it is essential to avoid over-reliance on cash. Emergency savings can also be facilitated by a savings account.
According to a recent survey conducted by the American Association of Individual Investors, cash made up an average of 19.7% of investors’ portfolios in October. Stocks made up 64.4% of portfolios, while bonds constituted 15.8%.
In September, cash allocations increased by over 1%, while stock allocations decreased by approximately 1%. Although the average cash share in portfolios has declined from nearly 25% last October, it remains below the historical average of 22%.
Overemphasizing cash in long-term financial planning can prove to be a detrimental strategy. Experts, including those at Nuveen, have cautioned against becoming too heavily invested in cash or short-term Treasury debt.