CIO maintains the view that investors should stay invested, as holding excess cash comes with a potentially significant risk to long-term wealth growth. (ddp)

This underlines increasing competition among US lenders for consumer cash, with regional banks rolling out offers such as sign-on bonuses worth hundreds of dollars for clients who keep cash in accounts for longer.

It also reflects a growing interest in cash investments, as cash rates have risen sharply over the past year amid central bank tightening. With recession fears now prominent in market narratives, investors may find a degree of perceived safety in deposits that offer solid returns.

But we maintain the view that investors should stay invested, as holding excess cash comes with a potentially significant risk to long-term wealth growth.

Reinvestment risks could damage returns. A balanced portfolio of equities and bonds has historically outperformed cash over most time horizons. And while cash rates are attractive today, it is important to consider reinvestment risks. A marked slowdown in inflation could lead to a rally in global equities, with the potential for a roughly 12% rebound by year-end in our upside scenario. Under such conditions, a deposit-heavy investor would have to choose between holding lower-yielding cash or paying a higher price for stocks.

Inflation is cooling, but will still erode the real value of cash. While US headline inflation in March eased to the slowest annual pace since May 2021, it remains elevated at 5% year-over-year. Historically, inflation has reliably eroded the real value of cash deposits, with a 21% decline in purchasing power for euros since 2007, 23% for US dollars, and 25% for sterling. While we believe inflation will continue to slow in the US and in Europe this year, it is likely to stay above central bank targets for some time to come.

Deposits lack diversification benefits. Fixed-term deposits can capture existing high rates and minimize the risk from aggressive central bank rate cuts, but lack the diversification benefit of high-quality bonds and would not provide the upside of bonds in the event of a recession. As Nobel Prize laureate Harry Markowitz pointed out, diversification is the only free lunch in investing.

So, to balance short-term risk and long-term growth, we recommend that investors set aside the resources they need for the next three to five years in a Liquidity* strategy, comprised of cash, short-duration fixed income products, and available credit facilities. The remainder of their wealth should be invested in a longer-term diversified portfolio of equities, fixed income, and alternative assets.

*Time frames may vary. Strategies are subject to individual client goals, objectives and suitability. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved.

Main contributors - Mark Haefele, Daisy Tseng, Vincent Heaney, Jon Gordon

Content is a product of the Chief Investment Office (CIO).

Original report - Higher cash rates conceal risks to long-term wealth growth, 19 April 2023.