Cold, hard cash! Who doesn't wish that starting in September, 2007, their portfolio consisted of nothing but? If then you'd converted to cash, every $10,000 you had would now be nearly $10,500. That same sum in the S&P 500 would be just $7,424 - a $3,000 difference in just over 2 years.
Investors have learned that lesson, and horde some $3.16 trillion in money market funds, less than the record $3.76 trillion that coincided with the stock market's bottom in March of last year, but still $1 trillion more than 2007's stock market top. If you add to money market funds the bank accounts and CDs that are waiting to be put to work, according to industry experts, investors' cash stash comes to over $11 trillion. That's about equal to the total value of the investable stock market, $10 to $12 trillion.
But that's the past. Will cash investors be as smug 30 months from now as they are if they've held cash for the last 30 months?
Interest Rates Have Never Been Lower
While investors always profess to be seeking value for their money, why do they gravitate to asset classes that have little value or yield? Whether it was Internet stocks generating no profits and trading at nose bleed multiples of website clicks in 2000, or condos in 2005 with tiny rents relative to their mortgages, many investors become mesmerized by past returns and overlook whether their investments offer any value.
That's the case with money market funds, many investors' vehicle for their cash. Their average yield is just 0.03%. At that rate, it'd take you 2,300 years to double your money!
Historically, cash yields have been much higher, averaging 3.9% since 1926. Indeed, they were in the double digits in the late 1970s and early 1980s, and at 5.05% as recently as the last stock market top.
Cash investments have rarely been pricier. Investors are paying a huge opportunity cost to hide in cash.
Does Cash Have a Chance Versus Inflation and Other Investments?
The nil yields on cash are particularly alarming when you consider inflation. Since 1913, prices have increased 3.5% annually on average. That means prices double in about 20 years.
What's the inflation outlook now? While nobody knows for sure, as US Government budget deficits surge to levels not seen since World War II, and the Federal Reserve presides over its most bloated balance sheet ever, stable currency supporters must be glum.
Historically, other investments have trumped cash. Since 1926, short dated Government bonds, a cash proxy, have gained 3.9% annually, longer dated bonds 5.6%, and equities 10.9%. At those rates in twenty years $10,000 grows to just $21,494 in cash, but $79,183 in equities.
But in Today's Perilous Times, Isn't Cash Justified?
Some argue that given the weak economy and the present uncertainties keeping large amounts of cash is justified.
However, consider whether today's travails are not already reflected in asset prices. While residential real estate is in a slump, prices may reflect this: The average home sells for levels first seen in 2003, down 28% from the peak.
Meanwhile, the stock market is at levels first reached in 1998 and has been marked down 25% from the peak, arguably completely offsetting the weak outlook.
Risk assets like stocks and real estate may now price in a muted rebound and higher than expected risks, and reward investors over time relative to non risk assets like cash. How else do you explain the stock market's 70% advance since last March?
In any event, today's economic pessimism may be unfounded: Many failed to predict the downturn; can they be trusted to predict the lack of a rebound?
An absolute risk is the constant erosion of the Dollar's purchasing power. Without hard money backing or external limit to the printing presses, that risk may never have been greater.
If your goals are long term, don't let your perception of risk in the economy and the markets cause you to invest in cash.
Will Cash Allow You To Time Your Entry Into The Markets?
Many justify their cash as "dry powder" to time their entry into the stock market. That's a daunting task. Short term calls are tough for even the best in the business. Warren Buffett admonished investors on October 16, 2008 to "buy America," because he was. The stock market proceeded to drop another 35%.
The dry powder justification for holding cash, though sounding so prudent, is extremely difficult to execute, while the cost for holding the dry powder has never been greater.
Are Interest Rates Only Going Up?
Many justify large cash stashes by arguing that interest rates are only going up. While today an investor can get 120 times more yield from a 10 year US Government bond (yield 3.6%) versus the 0.03% of the typical money market account, the fear is that if interest rates rise they will regret not having waited to invest in, say, the new 4% 10 year bonds.
It's not clear that the probabilities favor that approach. First, interest rates may not go up. The economy is weak, inflation is a no show, there's little loan demand. Investors may continue to shun riskier assets in favor of US Government bonds.
Interest rates could fall. They are lower in Germany right now, where its 10 year bond yields just 3.1%, while Japan's yields just 1.3%. Our 10 year bond has yielded less, as little as 2.2% in December, 2008.
Before anyone argues that interest rates are "not where they should be," consider that nearly $1 trillion of bonds are traded daily in this country. For each seller, there's a buyer, and vice versa. The current rates reflect the consensus of the appropriate rate for the next, say, 10 years. Be cautious in asserting that consensus is wrong. What do you know that they don't?
To stay in cash while waiting for higher rates can be analogized to a landlord keeping his condo empty while he waits for higher rents to prevail. The certainty of foregone rents today is a high price to pay for the possibility that at some time in the future rents will be materially higher.
There Will Be a Time for Cash
Consider, too, dividend yields versus cash yields. When cash yields more, cash makes more sense and you can shift accordingly. Right now is not the time, as the average yield on stocks (2.5%) is some 83 times greater than the paltry 0.03% on money market accounts.
Although market timing has a low probability of success, valuation analysis can indicate times when cash makes more sense. For example, back in the year 2000 the earnings yield on stock (the inverse of the price to earnings ratio) was as low as 3%, but money market accounts yielded nearly 5.3%. The math was easy then to shift some equities to cash.
Currently the Government in an attempt to jumpstart the economy has made interest rates for cash virtually zero. Reduce your holding of that clunker asset class in favor of longer dated risk assets like bonds and equities.
Despite the Low Yields Cash Can Still Make Sense for Your Personal Situation
Consider your personal financial circumstance to determine the right level of cash. The lighter your nest egg relative to your financial obligations, the greater should be your cash allocation. Cash serves as insurance; in the same way you might pay greater premiums for an auto policy with a lower deductible should your nest egg be smaller, you'll need to pay the price of a greater allocation to cash if circumstances require.
Some investors seek cash to reduce the volatility of their portfolios. This "sleep well at night factor" is legitimate; if dampening the swings in your nest egg allows you to stay the course then by all means include a healthy allocation to cash. You don't want the perfect, in the form of a risky portfolio that may provide greater returns but will generate too much angst, to prevent you from devising a good portfolio that takes into account the volatility you can live with.
Sum Up
Cash has never been more expensive yet its allocation in portfolios is at near record levels. While personal circumstances may justify this, long term portfolios should consider downsizing cash to take advantage of better prospects elsewhere.
By David G. Dietze, JD, CFA, CFPâ„¢
President and Chief Investment Strategist
Point View Financial Services, Inc.
Investors have learned that lesson, and horde some $3.16 trillion in money market funds, less than the record $3.76 trillion that coincided with the stock market's bottom in March of last year, but still $1 trillion more than 2007's stock market top. If you add to money market funds the bank accounts and CDs that are waiting to be put to work, according to industry experts, investors' cash stash comes to over $11 trillion. That's about equal to the total value of the investable stock market, $10 to $12 trillion.
But that's the past. Will cash investors be as smug 30 months from now as they are if they've held cash for the last 30 months?
Interest Rates Have Never Been Lower
While investors always profess to be seeking value for their money, why do they gravitate to asset classes that have little value or yield? Whether it was Internet stocks generating no profits and trading at nose bleed multiples of website clicks in 2000, or condos in 2005 with tiny rents relative to their mortgages, many investors become mesmerized by past returns and overlook whether their investments offer any value.
That's the case with money market funds, many investors' vehicle for their cash. Their average yield is just 0.03%. At that rate, it'd take you 2,300 years to double your money!
Historically, cash yields have been much higher, averaging 3.9% since 1926. Indeed, they were in the double digits in the late 1970s and early 1980s, and at 5.05% as recently as the last stock market top.
Cash investments have rarely been pricier. Investors are paying a huge opportunity cost to hide in cash.
Does Cash Have a Chance Versus Inflation and Other Investments?
The nil yields on cash are particularly alarming when you consider inflation. Since 1913, prices have increased 3.5% annually on average. That means prices double in about 20 years.
What's the inflation outlook now? While nobody knows for sure, as US Government budget deficits surge to levels not seen since World War II, and the Federal Reserve presides over its most bloated balance sheet ever, stable currency supporters must be glum.
Historically, other investments have trumped cash. Since 1926, short dated Government bonds, a cash proxy, have gained 3.9% annually, longer dated bonds 5.6%, and equities 10.9%. At those rates in twenty years $10,000 grows to just $21,494 in cash, but $79,183 in equities.
But in Today's Perilous Times, Isn't Cash Justified?
Some argue that given the weak economy and the present uncertainties keeping large amounts of cash is justified.
However, consider whether today's travails are not already reflected in asset prices. While residential real estate is in a slump, prices may reflect this: The average home sells for levels first seen in 2003, down 28% from the peak.
Meanwhile, the stock market is at levels first reached in 1998 and has been marked down 25% from the peak, arguably completely offsetting the weak outlook.
Risk assets like stocks and real estate may now price in a muted rebound and higher than expected risks, and reward investors over time relative to non risk assets like cash. How else do you explain the stock market's 70% advance since last March?
In any event, today's economic pessimism may be unfounded: Many failed to predict the downturn; can they be trusted to predict the lack of a rebound?
An absolute risk is the constant erosion of the Dollar's purchasing power. Without hard money backing or external limit to the printing presses, that risk may never have been greater.
If your goals are long term, don't let your perception of risk in the economy and the markets cause you to invest in cash.
Will Cash Allow You To Time Your Entry Into The Markets?
Many justify their cash as "dry powder" to time their entry into the stock market. That's a daunting task. Short term calls are tough for even the best in the business. Warren Buffett admonished investors on October 16, 2008 to "buy America," because he was. The stock market proceeded to drop another 35%.
The dry powder justification for holding cash, though sounding so prudent, is extremely difficult to execute, while the cost for holding the dry powder has never been greater.
Are Interest Rates Only Going Up?
Many justify large cash stashes by arguing that interest rates are only going up. While today an investor can get 120 times more yield from a 10 year US Government bond (yield 3.6%) versus the 0.03% of the typical money market account, the fear is that if interest rates rise they will regret not having waited to invest in, say, the new 4% 10 year bonds.
It's not clear that the probabilities favor that approach. First, interest rates may not go up. The economy is weak, inflation is a no show, there's little loan demand. Investors may continue to shun riskier assets in favor of US Government bonds.
Interest rates could fall. They are lower in Germany right now, where its 10 year bond yields just 3.1%, while Japan's yields just 1.3%. Our 10 year bond has yielded less, as little as 2.2% in December, 2008.
Before anyone argues that interest rates are "not where they should be," consider that nearly $1 trillion of bonds are traded daily in this country. For each seller, there's a buyer, and vice versa. The current rates reflect the consensus of the appropriate rate for the next, say, 10 years. Be cautious in asserting that consensus is wrong. What do you know that they don't?
To stay in cash while waiting for higher rates can be analogized to a landlord keeping his condo empty while he waits for higher rents to prevail. The certainty of foregone rents today is a high price to pay for the possibility that at some time in the future rents will be materially higher.
There Will Be a Time for Cash
Consider, too, dividend yields versus cash yields. When cash yields more, cash makes more sense and you can shift accordingly. Right now is not the time, as the average yield on stocks (2.5%) is some 83 times greater than the paltry 0.03% on money market accounts.
Although market timing has a low probability of success, valuation analysis can indicate times when cash makes more sense. For example, back in the year 2000 the earnings yield on stock (the inverse of the price to earnings ratio) was as low as 3%, but money market accounts yielded nearly 5.3%. The math was easy then to shift some equities to cash.
Currently the Government in an attempt to jumpstart the economy has made interest rates for cash virtually zero. Reduce your holding of that clunker asset class in favor of longer dated risk assets like bonds and equities.
Despite the Low Yields Cash Can Still Make Sense for Your Personal Situation
Consider your personal financial circumstance to determine the right level of cash. The lighter your nest egg relative to your financial obligations, the greater should be your cash allocation. Cash serves as insurance; in the same way you might pay greater premiums for an auto policy with a lower deductible should your nest egg be smaller, you'll need to pay the price of a greater allocation to cash if circumstances require.
Some investors seek cash to reduce the volatility of their portfolios. This "sleep well at night factor" is legitimate; if dampening the swings in your nest egg allows you to stay the course then by all means include a healthy allocation to cash. You don't want the perfect, in the form of a risky portfolio that may provide greater returns but will generate too much angst, to prevent you from devising a good portfolio that takes into account the volatility you can live with.
Sum Up
Cash has never been more expensive yet its allocation in portfolios is at near record levels. While personal circumstances may justify this, long term portfolios should consider downsizing cash to take advantage of better prospects elsewhere.
By David G. Dietze, JD, CFA, CFPâ„¢
President and Chief Investment Strategist
Point View Financial Services, Inc.
