We have emphasized here at GregoryBresiger.com that stocks produce the best long-term returns, about nine percent a year, of most asset classes. That is why they need to be in most long-term investment plans. But we have also said that it is important to also have bonds in a long-term plan. That’s because bonds, whose long-term return generally are about four percent a year, from time to time beat stocks. That usually happens when stocks are going through bad times such as the first decade of this century.
Having bonds as well as stocks reduces investment risk, although sometimes even the combination of stocks and bonds isn’t enough protection against disastrous markets. So now it is time to consider another important asset class. It is one often overlooked because its returns are often paltry compared to stocks and bonds.
Cash or cash equivalents, such as money market accounts or certificate of deposits, can also be important.
Over short periods, they can do better than bonds or even stocks. It’s also important to have a certain amount of cash on hand to help one survive difficult periods such as a time of unemployment, but also because once in a while cash shines as an asset class.
Sometimes It’s Vital
Cash isn’t trash, at least not over short periods when equities stink and bonds also reek.
Yes, stocks beat cash over the long term most of the time, but there’s still periods, even as long as a decade, when cash is a better investment than stocks, according to a LendingTree.com study. In a recent 51-year period cash was the best performing asset 30 percent of the time, the study found.
Hard times for equities often mean all that glitters is not financial assets, but garden variety cash, such as certificates of deposit (CDs).
“Unsurprisingly, CDs outperform stocks more often during economic recessions and underperform during economic expansion, although there are pockets of exceptions,” according to the study.
Have Several Kinds of Investments
The author of the study said it is important to remind investors that over relying on any one asset class is dangerous.
“We did this study as a wake-up call to make people understand that one needs more than just stocks and bonds as a diversifier; that stocks and bonds can sometimes go down together as in 2008,” said Brian Karimzad, vice president of research for MagnifyMoney, a LendingTree subsidiary.
He added that, for the average investor, cash as a part of a properly diversified portfolio can be important for a number of reasons. A cash reserve can be critical in hard times; when someone has lost a job. Cash can also be an effective investment when equities are pricey, Karimzad said.
For instance, six-month certificates of deposit, the study said, did very well at the beginning of the period known as the lost decade. That’s when CDs had the longest time of beating stocks, a 33-month period from 2000-2003.
“The 1-year return of 6-month CDs beat the 1-year return of stocks for 33-consecutive months,” according to the study.
Cash Is King
There have even been whole decades when cash turned in a commendable performance. The 1970s and 2000s were the two decades when annualized CD performance beat stocks, the study said. The latter period was known as “the lost decade” when stocks gained nothing.
When cash was glittering, when it was outshining equities, the average length of out-performance was about eight months, the study said.
That’s one reason why smart advisors sometimes use cash in a long-term plan.
“There’s a time and a place for every asset class, especially one that is much less expensive than alternative assets,” according to Anthony Ogorek, a veteran certified financial planner (CFP) in Buffalo, New York.
Ogorek, who uses short term treasury bills as his cash portfolio diversifier, sometimes opts for cash. That’s because, he adds, it “is much less opaque than other assets. And because cash is highly liquid, it can be a relatively attractive asset for a small number of clients.”
He says that in some of his client’s cash is somewhere between five percent and ten percent of the portfolio. Besides the conservative client who wants to preserve wealth, cash can also make sense for the younger client when stocks are smelling up the investment world, he says.
Be Prepared with Some Cash Ammo
“By having some money in cash, you are able to have some dry powder; to have some money ready to invest when markets start to recover. If you’re all in stocks all the time, that isn’t the case,” Ogorek notes.
But how does one use cash?
Karimzad, along with Ogorek, said traditional banks are not offering the full value of cash investments through their savings accounts.
By contrast, Karimzad recommends using online banks and going directly to the U.S. government. He says one can often obtain a better deal on cash than traditional banks. Treasurydirect.gov. as well as online brokers and banks that offer better rates than traditional banks are among his recommendations.
One can usually find between two and a half percent and three percent at these sites, Karimzad says.
He also says one can compare various rates by going to his company’s site: https://www.magnifymoney.com/compare/certificate-deposit/
Cash Can Be Useful, but with a Caveat
Still, despite the sometimes advantages of cash, over the long run there’s no question that cash stinks to high heaven compared to equities.
Indeed, Ogorek emphasizes that stocks usually are the biggest part of a long-term portfolio, a choice supported by the LendingTree study. And history says that’s the right approach.
A Half Century of Research
In the 51-year period of the study, $1,000 invested and reinvested in six-month certificates of deposit would be worth $16,200 today. A thousand dollars invested in the S&P 500, the study said, would be worth $140,130.
Still, remember that there are periods when cash isn’t trash; when cash is glowing. That is a reason why almost every portfolio, why almost every investor no matter the age, should have some cash.