We've all heard the saying, "Cash is King!" While I agree with its intention, current economic factors like inflation and the explicit move away from the US Dollar as the global standard currency by BRICS countries have shined the spotlight on the flaws of this statement. (Brazil, Russia, India, China, South Africa)
Forget comparing what $1 gets you in the 1950s compared to now. Instead, compare what you were able to buy just 4 years ago in 2020 versus now in 2024.
Obviously, cash loses its royalty cache when inflation crashes the party. Please don't misunderstand. One still needs to have a cash-based emergency fund in case of true emergencies like loss of a job or death of a loved one, but having too much cash parked on the side is clearly exposes vulnerability.
Given the market crash of 2022, where the S&P was down nearly 20% and the Nasdaq down 33% for the year, investors have every right to be wary of the market and react by pulling investments out of the market and moving into something "safe" like cash. But alas, being trapped by having too much cash is a real-world problem. This is why this paper from JPMorgan titled "Avoiding the Cash Trap: Why and How to Step Out of Cash," caught my attention.
In this JPMorgan paper, 7 cash traps are highlighted:
Opportunity cost from holding too much cash
When cash performs well, other assets typically perform better
When inflation is a factor, investors need their portfolios to do more
High-quality bonds provide both portfolio protection and ongoing income
All-time highs aren't trouble for the stock market
Waiting to get back into the market is a losing proposition
Time is on the side of a long-term investor
I won't rehash each point. The JPMorgan paper is well worth a read. But suffice it to say that having too much cash sitting on the side can be very costly. Here are some key highlights from the paper:
From Sep 2023 to Jun 2024, the S&P 500 returned 29%, a 60/40 portfolio returned 20%, and a generous short-term CD returned 7%. (page 5)
A well-balanced portfolio with diversified investments and proper asset allocation experiences much lower volatility and better overall returns than straight cash positions. (page 7)
Investing in higher-risk assets (stocks and stock funds) yields higher returns in the long term. If you have a long runway (a.k.a., time horizon), stay invested and let compounding do its work. (page 9)
In general, when interest rates fall, bond prices go up. This is the economic condition we're living in now. Use high-quality bonds to reduce the risk in your portfolio while generating an ongoing income through dividends. (page 11)
Historically, even if you invest at the market's all-time high point, the growth of your portfolio yields similar, if not better, long-term performance. (page 13)
Based on historical data, missing 10 best days in the market can easily cut your overall returns in half. (page 15) In fact, based on what I shared in our Teen Manifesto, the best market-performing days typically occur near the worst market-performing days.
The longer your investment time horizon, the lower overall volatility and the more targeted range your investment returns will be. (page 17)
It’s time to rethink the role of cash. Clinging to it as a primary financial strategy during an economic downturn is not necessarily the safest bet. While having a cash reserve for emergencies is prudent, relying too heavily on cash can expose you to significant opportunity costs, especially during inflation. By diversifying your portfolio and staying invested, even during market downturns, your future self will thank your current self for providing long-term growth and stability to your investments.
Comments