National Post (National Edition)
THE WORST THING NERVOUS INVESTORS CAN DO RIGHT NOW? GO TO CASH.
Human emotion can have a powerful influence over portfolio design especially when there is universal negativity about the state of the economy. Today, we’re unfortunately in just such a state: Global PMI indexes are flashing recession, the U.S., U.K. and to an extent Canada are facing political uncertainty, and talk of trade wars continues to escalate.
This may motivate an investor to go to cash, which, contrary to what many may believe, is exactly the wrong thing to do in such times. Unfortunately though, this happens to be one of the most common actions taken especially among many of the do-it-yourself portfolios that we’ve reviewed.
So if you’re tempted to hit that sell button and park the money under your mattress, here are three reasons why you should reconsider:
• Inflation and death by a thousand paper cuts
Ray Dalio, the founder of Bridgewater, offers some great perspective on why going to cash is simply a bad idea.
“That’s the worst thing you could do because it is the surest tax on your money. You will bleed slowly to death, because the after-tax returns are lower than inflation by a little per year.”
Even though inflation is quite low at the moment, it is well above short-term deposit rates and so having too much of a cash weighting could have a profound impact such as not saving enough for retirement or accelerating the depletion of one’s assets for those living off of them during retirement.
For example, we ran a planning analysis for a fictitious retired couple spending a combined $100,000 per year with $2.25 million in assets (blend of registered and non-registered) and a two per cent inflation rate.
In the first scenario we assumed a 50/50 split in the assets between cash and equity which resulted in a terminal value (age 67 to age 90) more than half that than if their assets were in a 5/45/50 cash, fixed-income and equity portfolio. This is quite significant given we assumed fixed income only earned a 1.75 per cent premium to cash.
• Market timers beware
Putnam Investments recently did a great study showing the impact of what happened if an investor missed the 10, 20, 30 and 40 best days in the market from Dec. 31, 2003 to Dec. 31, 2018.
For example, let’s say an investor’s market timing resulted in them missing out on only the 10 best days in the S&P 500 over the past 15 years. This resulted in a $10,000 investment growing to $15,481 (2.96 per cent annualized return) or almost half that of the $30,711 (7.8 per cent annualized return) if they had stayed fully invested. If they missed out on the 20, 30 or 40 best days their $10,000 investment would be much worse at only $10,042, $6,873 and $4,943, respectively.
• Lower returns and greater risk than fixed income
Many believe that going to cash is a safest way to protect against a market correction. That said, history has shown that fixed income has proven to offer a lot more downside protection to a portfolio without having the same performance drag risk.
For example, we ran our own numbers over the same aforementioned 15-year period but assuming a 30-percent weighting to a blend of short- to long-term U.S. treasuries versus a 30-percent weighting to cash both offsetting a 70 per cent weighting to the S&P 500.
We calculate that a portfolio with fixed income only gave up 39 basis points in annual performance to an all-stock portfolio compared to a 168 basis point deficit in the portfolio that held cash. Importantly, the worst year of the portfolio with fixed income was a 20.5 per cent loss better than the 37.1 per cent loss in the all-stock portfolio and surprisingly, the 25.5 per cent loss in the portfolio with cash.
In conclusion, we think cash should play a role in a portfolio especially if one has upcoming liquidity requirements but making moves on fear over a market correction can prove to be quite costly.
Financial Post