In times of market uncertainty, investors often turn to cash for safety, but higher interest rates have made cash more appealing recently. What role should cash play in investor portfolios today?
Money market funds have seen significant inflows, reaching all-time highs, due to the higher interest rates on cash instruments. This is because the Fed raised rates rapidly from early 2022 to mid-2023 and has kept the federal funds rate in a range of 5.25% to 5.50% since last July.
Money market funds have experienced significant inflows
Cash is essential for financial planning and investment purposes, providing liquidity for expenses, emergency funds, and reducing portfolio risk. But holding too much cash can be problematic as inflation erodes its value over time, and the opportunity cost of not investing in stocks or bonds can be significant.
Inflation erodes the value of cash
The second challenge with holding excess cash is the opportunity cost of not investing in stocks or bonds. Just as interest rates have risen for cash, yields have also jumped across many types of bonds. The average yield on U.S. investment grade corporate bonds, for instance, is now 5.5% – far more attractive than the average of 3.7% since 2009. Unlike cash, these yields are longer-term in nature and these bonds could experience price appreciation if rates do decline.
Similarly, the stock market has performed extremely well despite many investor concerns over the past few years. The S&P 500 is still up 8% with dividends and has gained about 47% since the market bottom in 2022. While the past is no guarantee of the future, these returns have far outpaced inflation and would have helped to offset the erosion of purchasing power across a portfolio.
Stocks and bonds have outpaced inflation over history
In the long run, holding a proper allocation of stocks and bonds is still the best way to achieve financial goals.
