Despite the strong equity market recovery in January, I'm still meeting with investors that are shaken and upset about the sell-off at the end of 2018. Those equity market losses will ultimately prove to be temporary, and hopefully advantageous to wealth accumulation, assuming an investor was allocated appropriately going into the decline and made reasonable decisions during the sell-off. Check out our Bear Market Guidebook for more of our thoughts on that subject.
What I don't hear is a lot of panic about the 15% decline in the value of cash over the last decade (Fig. 1) or big sighs of relief that it seems to have abated.
Fig. 1: Purchasing power declines in 3-month Treasury Bills, 1955–2018
Unlike the equity market decline, the losses in cash are likely to be permanent. Absent an unforeseen technological advance that significantly spurs economic growth, it will take multiple market cycles and a lot of luck for cash to regain the real buying power it had in 2008.
There are other areas where nominal and inflation-adjusted outcomes can be very different. For instance, US investors currently don't get an inflation step-up when they pay tax on realized gains. That lack of an inflation adjustment means investors are paying tax on both real gains and inflation, but no one really complains or appeals to questions of fairness. It is rarely even recognized, even though inflation can cause the nominal value of an asset to double in 20 years without any real wealth gains for the holder. The government does the same thing with Social Security and Medicare adjustments to reduce costs or increase premiums in an advantageous way.
There's an obvious behavioral lesson from this experience that will be interesting to think about as we head into the next US presidential cycle. Shock-and-awe tax policies get headlines, but if you want to raise taxes or reduce benefits, you should think in real instead of nominal terms, andapparently most people won't object too strongly.
Author: Michael Crook, Head Americas Investment Strategy, UBS Financial Services Inc. (UBS FS)