For the first time in a long while, cash is finally king. With the yield on the 30-day U.S. Treasury bill topping a whopping 5% in May 2023, and certificates of deposit and high-yield savings accounts offering over 4%, it seems that holding onto cash is more profitable than it has been in years, even after accounting for inflation. This shift into positive territory, following years of negative real yields, has investors wondering whether it’s time to increase their cash holdings or hold onto their cash as they scout for more favourable market opportunities.
However, this high yield environment may not be as rosy as it seems. According to Veronica Willis, a global investment strategist at the Wells Fargo Investment Institute, having a large portion of a portfolio in cash can lead to "unintended consequences". While cash yields may remain high in the short term, historical trends show that cash is likely to underperform other growth assets over the long term, potentially hindering overall performance. In fact, several strategists argue that longer-dated bonds could be on the cusp of outperforming, especially if the Federal Reserve is nearing the end of its rate-hiking cycle.
Investors Beware: High Cash Yields Might Disguise Pitfalls
For the first time in a long time, it pays to hold cash, even after inflation. However, an investment strategist at Wells Fargo Investment Institute (WFII) warns that high yields could potentially mask pitfalls for investors.
Cash Yield Movement
In May 2023, the yield on the 30-day U.S. Treasury bill surpassed 5%, a trend that continues to date. Simultaneously, certificates of deposit and high-yield savings accounts paying over 4% have become available. Meanwhile, inflation, measured by the consumer-price index, fell from 9.1% in mid-2022 to 3.2% in July. According to a WFII chart, cash yields have transitioned into positive territory on a real, inflation-adjusted basis after several years of negative real yields.
The Cash Dilemma
Investors are left wondering if it’s time to increase cash holdings or keep their funds liquid while waiting for better market entry opportunities, says Veronica Willis, a WFII global investment strategist. However, Willis warns that parking too much of one’s portfolio in cash can lead to “unintended consequences.” The issue is that, while cash yields may remain high in the short term, history suggests that cash tends to underperform other growth assets over the long term, thereby hindering long-term performance.
The Bonds and Stock Perspectives
On another note, some strategists argue that longer-dated bonds are likely to outperform if the Federal Reserve is close to or at the end of its rate-hiking cycle. The 10-year Treasury yield reached its highest point since 2007 earlier this month, but has since pulled back. Contrarily, stocks ended higher on Tuesday, despite a 2023 rally experiencing a setback in August.
The Long-term View
Willis points out that even a very conservative allocation, such as “moderate income,” has historically returned more than cash over extended periods. A diversified allocation tailored to an investor’s goals and risk tolerance can be more effective at capturing the upside return potential of growth assets while also smoothing volatility compared to a concentrated position.
While high cash yields may seem attractive, investors should tread carefully. High short-term returns may mask long-term underperformance compared to other growth assets. A diversified portfolio tailored to individual goals and risk tolerance can be a more effective strategy. Despite the current positive cash yield environment, WFII strategists anticipate every strategic asset class to outperform cash over the long term based on their capital market assumptions.