by Jesse Anderson, CFA
“Part of being a good investor is accepting uncertainty.” – Kurt Shrout, Minimizing Cash is King
With markets reaching all-time highs, I’ve seen many articles discussing the role of cash in a portfolio. I believe one of the biggest reasons investors have moved a considerable portion of their portfolios to cash is certainty. In making this decision, some investors may not fully consider these different types of risks:
Loss in Purchasing Power
The average current interest rate paid on cash balances is less than .25%. The current inflation rate in the U.S. is 2.0%. This means each year the real return on cash is -1.75%. Roughly speaking, investors would need to purchase a ten year treasury to match the current inflation rate. Not only would this lock up funds over the long-term, it also exposes investors to future interest rate increases. Money sitting in cash will purchase fewer and fewer goods in the current zero interest rate environment.
Missed Investment Gain
Since March of 2009, the stock market has done well. Coming off one of the worst declines in modern stock market history, investors jumped into cash for certainty and to stop the losses. The result? Losses during the bad times and little participation during the recovery. Everyone’s familiar with the long-term historical return of the stock market in the 8-10% range. This includes the 50% bear markets and the anticipated recoveries to new highs. Since March of 2009 the major indexes have already doubled and recouped all their losses. I doubt this is the case with anyone’s cash.
Poor Market Timing
Most investors don’t plan on holding cash forever. Instead, it is a temporary “investment” until things calm down. However, it is our nature to get these decisions wrong time and time again. In fact, we normally do the exact opposite of what we should be doing. Our emotions drive us to sell when prices are down and buy when they are up. Very few people get these decisions correct; it is highly unlikely you will be one of them.
Uncertainty, or risk, is something all investors must face with their investments. While we’ve all felt the pain of stock market risk, don’t overlook the risks that come with keeping significant portions of your assets in cash.