Investing is an activity that always bears some risk, but the exact nature of this risk is often misunderstood. During the first half of 2019, investors piled $255 billion (net of withdrawals) into bond funds while liquidating a net $45 billion from stock funds even as stock prices moved higher. Investors have clearly shown their preference for short-term bond funds and other near cash investments, but this begs the question: Is cash a conservative investment? Is cash really less risky?
Let’s consider three primary risk components that stocks and bonds share: volatility; inflation; and loss of capital.
We list volatility as one of the risks above but most investors seem to think it’s the only type of risk. Volatility or price variability is transient; the other risks are permanent. In this super simple chart above the cash/short term bonds category has two risks marked ‘good’ while stocks just have one. That’s the reason stock investors receive better long-term returns. The ‘cost’ of the additional return is some emotional discomfort.
Cash Is Not a Safe Haven
The ever-unhelpful financial media portray investing in short term bonds (cash or near cash) as a ‘safe haven’, but failing to keep pace with living cost increases destroys the central reason for investing in the first place; to maintain purchasing power. Can an investment properly be denoted ‘safe’ or ‘conservative’ when it doesn’t achieve the primary long-term objective for investing?
I mention the various risks above which is the entire focus for those who believe cash is conservative. But investing is about preparing for something in the future, so we need to consider the returns side of the equation as well. Since 1960, inflation is up about 9X but the S&P 500 Index has increased about 50X. Seems simple enough, but in between, there were a couple dozen times when the stock market declined by 15% or more. You have to be able to focus on the ultimate aim and not dwell on the near term in order to accrue the positive market returns. There are no short-cuts.
Don’t Run for the Hills
Many investors want a hiding place from volatility and run for the exits moving their money to cash and short-term bonds at the first sign of trouble. The evidence, however, shows clearly that to reap the long term returns from the stock market you must be invested in all market conditions, not just times when it feels ‘safe.’ That’s really the essence of investing. The only way to protect invested capital from inflation is to be in the market ‘full-time.’
The elixir of certainty can be enticing but it stands directly in the way of achieving the overarching objective for most investors. Preparing for the future and protecting your money from inflation go hand in hand. Start there. Ready for a real conversation?