The chart below is from a recent Wall Street Journal article depicting the record amount of cash currently sitting in money-market funds and CDs1.
We’ve argued for many months that this “dry powder” could be deployed into the stock market as early as this year and be a potential source of added fuel to this equity bull market. The author seemingly agrees.
However, what surprised me was how many young Americans interviewed for the article were happy with the yields currently offered from cash. Aside from taxes and inflation wiping out most gains, there’s a deeper concern with this sentiment.
The visualization below is from Brian Feroldi, a well-respected author with a gift for simplifying financial concepts2.
In the short term, stocks are indisputably riskier than cash. Nobody knows where the equity market will go over the next 12-18 months, stocks are very volatile, and trying to time the market is a fool’s errand. But the tables turn over time because stocks offer a higher expected return, protection from inflation, etc.
Charlie Bilello at Creative Planning quantifies this “risk shift” in the two charts below. The first shows the odds of cash beating the stock market fall quickly. Over one year, cash has a 31% chance, but in any 10-year period, the odds move down to 15%. In every 25-year period going back to the Great Depression, the S&P 500 has beaten cash3.
The second depicts the cost of sitting in cash, and it’s been astronomically high. The average opportunity cost of holding cash over a one-year holding period has been 8%. Over 30-year periods, this cost grows to 2,124%4. That’s simply devastating.
Add it all up, and investors enjoying the historically high returns in cash today could be setting themselves up for a long road ahead by falling victim to the famous words from Johann Wolfgang von Goethe:
“The dangers in life are infinite, and among them is safety.”
The bottom line
My wife and I bought a fixer-upper in 2020, and we postponed renovations until our daughter’s foot went through the hardwood floors a few years later. After removing more splinters than we care to admit, we began meeting with general contractors who all told us the same thing. This project was going to be expensive.
We had a choice to make. Either we devise a plan to complete the renovation without risking our finances or sell our daughter to pay for it all. While she’s cute enough to merit a premium valuation, we ultimately chose to keep her, which meant we had some work to do.
We signed the contract right around the lows in the stock market in late 2022, and every inch of my body wanted to take the cash we set aside for the project and put it in the market. The chart below shows that stocks have crushed the competition over time5, so my natural inclination was to back up the truck.
We didn’t realize it then, but that would have been a great time to buy! The S&P 500 has not only recovered from the lows back then but is now trading at another all-time high. Had we just bought an index fund at the start of the project, we’d look like rock stars today.
But we didn’t because of Mr. Feroldi’s visualization above. Stocks are way too risky to be considered for a project like this. For starters, it was scheduled not to go longer than six months (it went way longer). We were also on the hook for bills coming in twice a month. Had the market tanked at any point, we may have had to drain a college fund to pay for new plumbing.
Instead, we used a high-yielding cash solution at our firm that’s currently paying 5%, offers unlimited deposits and withdrawals at no fee, and provides FDIC insurance on a single account up to $16 million (the renovation was expensive but not that expensive). That way, we knew we could handle the bills along the way (pro tip: only sign fixed-bid contracts).
The bottom line is that cash is an indispensable tool that must be included in every financial plan. Use it for near-term expenses and as a safety net. But if the goal is to grow over any period longer than a couple of years, cash has historically done little more than lose money safely.
5 Total Real Return on Stocks and Bonds from Stocks for the Long Run, 1802-2012
This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.