Many wary investors are sitting on high levels of cash and cash equivalents,preferring to earn what looks like a decent yield in today’s higher interestrate environment rather than take on additional credit risk. But when does anabundance of caution turn into missed opportunity? How long is too long towait for a return to “normal”?
Fixed income can offer attractive starting yields
Bond yields are much more compelling with the substantial increase in interest rates over the U.S. Federal Reserve’s current hiking cycle. The Bloomberg U.S. Aggregate Bond Index ended 2023 at a yield of 4.5%, the highest level since before the 2008 financial crisis.
Since 100% of bond market returns are currently driven by income rather than price appreciation, these higher yields make fixed income investments an important part of a portfolio.1 And bonds continue to anchor portfolios through their naturally low-to-negative correlation to equities,2 helping to stabilize portfolio returns and lower volatility.
Inflation shrinks the value of savings
When overall prices increase due to inflation, the purchasing power of cash erodes over time. $1,000 today doesn’t buy what it did 10 years ago.
Investments like stocks and bonds can better keep pace with inflation over time. In fact, from 1928 to 2022, a portfolio of 60% stocks and 40% bonds held for 20 years or longer has produced a positive real return (adjusted for inflation) during all rolling time periods.
Investments like stocks and bonds can better keep pace with inflation over time.
Broad diversification can offer even more stability3
Whenever there is market uncertainty, investors may feel compelled to hold cash until the conditions appear more favorable. However, this market timing strategy has not been conducive to successful investing. While asset class leadership changes from year to year, a diversified portfolio provided competitive returns in most of the last 10 years and cash typically underperformed.
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Endnotes
Sources
1 Bloomberg, L.P., 31 Jan 1976 – 31 Dec 2023, 100% of the annualized total return of the Bloomberg U.S. Aggregate Bond Index was derived from coupon return as opposed to price appreciation. Index inception is 01 Jan 1976.
2 Morningstar Direct, 10-year period ending 31 Dec 2023. Correlation between the Bloomberg U.S. Aggregate Index and S&P 500 Index was 0.31.
3Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income.Diversification does not assure a profit or protect against loss.
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