We have been getting a lot of questions from clients lately about where to put their cash reserves. Since I last updated the table in Exhibit 1 in this post last August, the rates on all these instruments have literally doubled. If you have cash sitting at your local bank earning zero, you should absolutely move it. With minimal effort, we can get you a 4.5% in a money market fund or 5% on a 3 month CD. Where things get trickier is when people ask “why don’t I dump all my stocks/bonds and sit in cash at 5% until the market feels safe”?
Exhibit 1 – Current Rates on Cash Alternatives
Exhibit 2 shows average return on your cash for various historical periods. Over the long run getting 3-4% on it seems like a pretty decent deal, right? It does until we introduce the second column of data that shows average inflation for those periods. In real terms (after accounting for inflation), the return on cash is either paltry or outright negative, which is a problem. So what can one do to deal with inflation? That’s where other investments come in (Exhibit 3). Stocks have done the best in all these periods, while a 60/40 mix of stocks and bonds came in second. Cash was the worst place to be over the long run, except the last 10 years where attrocious 2022 return on bonds just edged out the cash. Gold, which is considered a great hedge for inflation, did ok in some periods but is still far behind stocks. Same goes for real estate, despite it having had a great 10 years.
If we go a step further and break these out by decade, the results largely hold (Exhibit 4). Stocks have been the best in all but four decades. They did come in last in 2000’s when they went through two major bear markets after the Tech Bubble and the Great Financial Crisis. 60/40 has generally had respectable and stable returns, earning its reputation as a “classic” asset allocation mix. Bonds had a nice bull market run from 80’s to 2021 when it came to a screeching halt. Real estate has been stable, if uninspiring (except pandemic-driven madness of 2020/21/22). Gold looks pretty bipolar, either best or worst in most decades. 1970’s is an outlier as “Prior to 1971, gold prices were fixed with the gold standard in place, and were mostly stable.”
Exhibit 2 – Average Pre- and Post-Inflation Return on Cash in Various Periods
Exhibit 3 – Average Real Return on Major Investment Assets in Various Periods
Exhibit 4 – Average Real Return on Major Investment Assets By Decade (best in green, worst in orange)
It can be difficult to wrap our heads around these long-term percentage returns. Let’s make it more digestible by translating it into dollar terms. If we assume that a typical American is invested in financial markets for say 50 years during their lifetime, here is what putting $100,000 in 1973 into these assets would look like by the end of 2022 (Exhibit 5). These are current dollar numbers after adjusting for inflation. While cash has barely kept up with inflation ending at $120k, stocks demonstrated the magic of long-term compounding ending at $1.9 million or 19 times the starting balance (again, after inflation). 60/40 is also very respectable at 11 times. Bonds, real estate and gold did ok but pale in comparison to stocks.
I looked at the 44 rolling 50 year periods going back to 1928 and stocks were the best place to be in every single one of them. 60/40 was the second best in all but one of the periods. Other assets fluctuated all over the place. So the last 50 year period is not a fluke. If you want to beat inflation and have good results throughout your investment lifecycle, you need a sizable allocation to stocks even in retirement.
Exhibit 5 – Ending Balance on a $100,000 Investment After 50 Years (Adjusted for Inflation)
As for the original question, of “why don’t I dump all my stocks/bonds and sit in cash at 5% until the market feels safe”? That would be trying to time the market, which is all but impossible to do successfully and consistently. Cash does outperform 60/40 allocation about 30% of the time, but knowing which 30% is the tough part even if it feels like a “no-brainer” in the current environment. Another financial blogger, Ben Carlson, had a great post on this with more rhetorical flourish and less data here, if you’d like to read another take on the futility of market timing.
Data notes: the data came from Professor Damodaran at NYU, you can download it here if you’d like to play with it. Investment assets are represented by the following indices:
3-month US treasury bill
10-year US treasury bond
60% S&P 500, 40% 10-year US treasury bond
Home price data from Robert Shiller (Case-Shiller Index)
Year-end prices for gold, per oz,
CPI for all urban consumers