The economy faces stubbornly high inflation, signs of a coming recession, and concerns over financial stability that have been stoked by a string of high-profile bank failures across the globe.
As if these concerns weren’t enough, stock market valuations (especially in the US) are already at elevated levels after the recent market rally, seemingly reflecting complacency about these risks.
Despite this backdrop, we believe that investors should move quickly to put cash to work in a balanced, well-diversified portfolio. Here are 10 reasons why investors should stay invested instead of retreating into the perceived safety of cash:
- A balanced, well-diversified portfolio is resilient to shocks. Stocks and bonds fell in tandem in 2022, which is an anomaly that has only happened in 2% of 1-year periods since 1926. Going forward, we expect stocks and bonds to exhibit their usual diversifying properties, with bonds protecting against sharp stock market losses and vice versa.
- High cash yields are an illusion. While cash may look attractive due to higher short-term interest rates, it is continuing to lose purchasing power due to inflation. Moreover, these levels aren’t likely last for long—cash rates may already have peaked in March as markets started to price in concerns over financial stability and economic growth.
- It is time to lock in high yields before they decline. The yield curve is inverted (short-term yields are higher than long-term yields), but bonds offer a way to lock in current yields in case rates fall due to recession fears. Unlike cash, bonds can enjoy significant price appreciation if rates fall.
- Bonds offer better protection during economic downturns. Bonds have an important role to play in a portfolio, particularly in times of uncertainty, and they have historically offered better protection than cash.
- Market timing can do more harm than good. In the long term, staying invested performs better than hoping to buy on a market dip—particularly if you’re putting cash to work in a balanced, well-diversified portfolio.
- Markets are more resilient than you may think. Historically, stocks and diversified portfolios have a strong track record of outperforming cash and inflation. Markets tend to recover very quickly from sharp declines, so it’s a good idea to put cash to work when one occurs.
- Hedging strategies can help to cushion the downside. Commodities and select hedging strategies can help to protect portfolios against risk.
- Alternative investments can help to diversify portfolios. Proper diversification goes beyond just equities and cash, and it should include alternative assets such as hedge funds.
- Dynamic asset allocation can help to protect against losses. Stocks tend to perform well when they have strong momentum, and more poorly when momentum is weak. Historically, we have seen strong returns from a systematic allocation strategy that increases the allocation to fixed income during periods of weak stock market momentum.
- The true risk is failing to meet your goals. At the end of the day, the true risk is failing to meet your goals. We recommend using the Liquidity. Longevity. Legacy. framework to align your portfolio with your investment goals both in the short and the long term. Cash can play an important role in meeting short-term spending needs, but it’s a poor tool for growing wealth over the long term.
In our view, it makes sense to build up a Liquidity strategy (comprised of cash, high-quality bonds, and borrowing capacity) during bull markets, so that you can deplete these reserves (instead of locking in losses in your long-term investment portfolio) during a bear market. We’re currently recovering from a bear market that began last year, so in our view this is a good time to be drawing down your cash reserves. After all, markets have historically staged a full recovery from their bear market losses within 3-5 years, and we are more than 1 year past the last bull market peak.
Timeframes 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.