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With 2 weeks to go in 2018, cash (short-term treasury bills) is king, outperforming all of the major global equity indices.
Intermediate-term bonds (10-year treasury) are also down on the year due to the rise in interest rates. If this holds through year-end, it would be the first time since 1969 that both stocks (S&P 500) and bonds (10-year treasury) finished a calendar year with a loss.
Meanwhile, Cash is on pace to have its best year since 2007 as the Fed continues to normalize interest rates.
The greatest fear among many investors is that this trend will continue.
Is this a rational fear? How often has cash outperformed stocks and bonds historically?
We have annual data on stocks (S&P 500), bonds (10-Year Treasury), and cash (3-Month Treasury) going back to 1928.
Since then, cash has been the top performer in only 13% of calendar years. As your holding period increases from 1 year to 30 years, the odds of cash being king declines from 13% to 0%. The opposite is true for stocks, which have been the top performer in 61% of 1-year periods, 80% of 10-year periods, and 100% of 30-year periods.
If the odds of cash outperforming are so low, why hold it at all? Because you may not have a 20-year holding period or you may not have a high enough risk tolerance to hold through short-term volatility in stocks and bonds.
Cash is the only asset class that will guarantee you a return of principal in the short run. While bonds do pretty well on this front they will at times lose out to cash during periods of rising interest rates. We saw that in 2009, 2013, and thus far in 2018.
When was the last time cash outperformed both stocks and bonds in a single calendar year? Way back in 1994. Which means that investors under 45 have never seen it and investors over 45 probably don’t remember it.
The trade-off from the safety that cash provides in the short run: lower long-term returns. Cash has annualized at 3.4% since 1928 versus 4.9% for bonds and 9.7% for stocks.
For investors with a 1-year holding period, accepting these lower returns is often the most prudent option, as both stocks and bonds could very well decline over that time period. But as your holding period increases beyond 10 years, cash makes less and less sense, as the probability of earning a higher return from stocks and bonds increases significantly.
Another way to look at this is to compare the maximum and minimum returns for stocks, bonds, and cash over various holding periods. What we find is that all 3 asset classes show a much lower variability (max-min) of returns in longer holding periods as compared to shorter holding periods.
For instance, the best 3-year period for stocks was 30.8% annualized while the worst 3-year period was -27.3%. That’s a spread of over 58%. Contrast this with the best and worst 30-year periods for stocks at 13.6% and 8.0%, a 5.7% spread.
In bonds, the spreads are less dramatic than stocks but show a similar narrowing as your holding period lengthens.
When the range of possible returns is wide, as is the case for shorter holding periods in stocks and bonds, cash is a more attractive option. As that range narrows with time, stocks and bonds become a higher probability bet.
With elevated valuations in stocks and low yields/rising rates in bonds, perhaps this will be the case in the short run (1-3 years). But in the longer run, it is unlikely that cash will beat a riskier portfolio of stocks and bonds. That’s not to suggest that holding some cash to sleep at night, for emergencies, or to withstand the higher volatility in stocks/bonds is a bad idea. I don’t think it is. But you probably shouldn’t be rooting for that cash to be your best investment. An environment in which cash is king for any extended period of time is not going to be a good one for investors.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors. He previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and also holds the Certified Public Accountant (CPA) certificate.
In 2017, Charlie was named the StockTwits Person of the Year. He is a frequent contributor to Yahoo Finance and has been interviewed on CNBC, Bloomberg, and Fox Business.
You can follow Charlie on twitter here.
Pension Partners, LLC is a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. For more information about Pension Partners please visit: https://adviserinfo.sec.gov/ and search for our firm name.
The information herein was obtained from various sources. Pension Partners does not guarantee the accuracy or completeness of such information provided by third parties. The information given is as of the date indicated and believed to be reliable. Pension Partners assumes no obligation to update this information or to advise on further developments relating to it.
Past performance is not indicative nor a guarantee of future results.
This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
The Standard & Poor’s 500, often abbreviated as the S&P 500, or just the S&P, is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ.
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