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Perhaps the Federal Reserve is finished raising interest rates, and perhaps the first rate cuts are just months away.
Still, it’s been a good ride for savers and risk-averse cash investors as the central bank jacked its benchmark rate from near 0% to its highest in two decades. The Fed’s key rate has stayed at a target range of 5.25% to 5.50% since July.
Those relatively high rates have made cash the “cool kid,” as one financial adviser put it, and people piled into bank certificates of deposit, high-yield savings accounts, money-market mutual funds and short-term Treasury debt. For now, it’s easy to find yields past the 5% mark.
Just don’t get too comfortable in cash, a new data analysis suggests.
The yields that cash can generate when interest rates hit a high point can’t match the stock returns that typically follow a high-rate period, according to Callie Cox, a U.S. investment analyst at the investing platform eToro. In fact, it’s not even close.
Cox scrutinized economic cycles going back to 1961, defining a cycle as the end of one recession and the start of another.
First, she found the top yield on a 1-year Treasury note
BX:TMUBMUSD01Y
in that cycle, using that as a proxy for cash returns. Then she found the top one-day S&P 500 performance following the date of that top yield, measured year over year. Here’s what she found:
For Cox, the findings are a warning that for all the draw of 5% cash investments right now, everyday investors who are cash heavy might want to increase their stock exposure.
“Cash is this warm fuzzy blanket,” she told MarketWatch. Still, she added, “in this moment in time, when the environment feels uncertain, it may pay off to take that risk, even though cash feels comfortable.”
After a crummy 2022, the S&P 500
SPX
is up nearly 12% year over year and nearly 19% higher for the year to date.
The stock market has been on a tear in November, rallying on the hopes that rate hikes are done and rate cuts are approaching. Stocks opened higher Thursday on the heels of new numbers from the Fed-favored inflation gauge. The data showed inflation rates staying unchanged in October and the year-over-year inflation rate dropping to 3% from 3.4%.
To be sure, 5% yields now are “historically attractive,” but that return on rate-sensitive cash investments is bound to change, Cox said.
There’s a time and place for cash investment, she emphasized. That depends on variables like a person’s risk tolerance, when they need money for a large purchase, and if they need a spot to park money while deciding the next investment move. Of course, savings accounts can also be vital for emergency savings.
In October, a monthly survey by the American Association of Individual Investors showed investors made cash an average 19.7% of their portfolio. Stocks constituted an average of 64.4% of portfolios, and bonds averaged 15.8%, the survey found.
Cash allocations increased by more than 1 percentage point from September to October, while stock allocations dropped roughly 1 percentage point, the results showed. Nevertheless, the average share of cash in a portfolio is down from nearly 25% last October, and below the survey’s historical average of 22%.
But cash looming too large in a person’s long-term financial goals is a strategy that can backfire, Cox said. She’s not alone in that view: Others, like experts at Nuveen, have also noted that it’s a “mistake” to get too heavy on cash or short-term Treasury debt.
“I see too many investors fall into the allure of cash and forget to take risk over time, which usually pays out,” Cox said.
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