Cash Is (NOT) King

Historically the role of cash in an investors’ portfolio has been to provide safety and liquidity.  It has always been prudent to maintain a reasonable cash balance to account for large, unexpected expenses, especially when those unexpected expenses come about more often than we would like. In the past couple of years, however, cash on hand has risen beyond recent historical levels as interest rates have gone up, given that they are now paying north of 5% on short-term savings. Cash in the investment world has morphed from a stability and liquidity holding into a play on interest rates and acting as an opportunistic portion of an investment portfolio. We feel investors have gone too far in this regard and should resist the temptation to keep their high cash balances and instead move these funds into other areas of the market.  Why?  Here are three charts to support our case.

This chart shows the differential between short-term US Treasury Bills and the Consumer Price Index, and the result here is that short-term cash has only recently had positive returns over inflation. If the Federal Reserve begins cutting interest rates again, this dynamic may change and revert to short-term cash rates earning less than inflation.

Historically, it’s been a good bet that after there has been a surge in cash levels, there has been a corresponding period of improved asset class performance as investors begin to rotate out of cash and into equities and bonds. We assign a strong probability of this happening again.

If you are a long-term investor, cash (green line) underperforms small stocks (dark blue line), large cap stocks (red line), intermediate term government bonds (yellow line), and only sometimes inflation (light blue line).

Bottom line:  Cash does, and always will have a role in investors’ portfolios as a stability and liquidity feature, but having too much may end up being an opportunity lost to other asset classes as our investment environment continues to normalize this year and next.

DISCLAIMER: Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this  newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this (article) serves as the receipt of, or as a substitute for, personalized investment advice from Elmwood Wealth Management. A copy of our current written disclosure statement discussing our advisory services and fees is available for review upon request.