Understanding Investments: Cash, Investments and Long-Term Planning

Monday 12 February, 2024

With short-term interest rates at the highest levels since 2008, it’s easy to sympathise with the view that cash looks tempting.

If investors can get 4% to 5% with no capital risk, why engage in stocks? And with no additional yield available on longer term bonds, why lock money away for the longer term?

But today’s cash rates may prove a mirage, especially if we approach a recession during the next 2 years. Of course, no-one knows the future economic outcome of the interest rate rises of the past 2 years, but if history is anything to go by, they usually create a recession (albeit recessions can be shallow or deep and the market expectations are for a shallow recession). In that instance, central banks will likely lower rates again to stimulate the economy.

We would expect core bonds to outperform in that scenario, as they have done in the 2 years at the end of each US rate hiking cycle since the mid-1980s (see the chart below).

Bonds outperform cash beyond peak rates

Relative performance of US bonds vs cash after interest peak rates

Source: Bloomberg, Bloomberg Barclays, Federal Reserve, ICE BofA, J.P. Morgan Asset Management. Market expectations are calculated using OIS forwards. Cash: ICE BofA 3-Month Treasury Bill Index; US bonds: Bloomberg Barclays US Aggregate Index. Past performance is not a reliable indicator of current and future results. Data as of 15 November 2023.

To give you an idea of what this could mean for investment returns, a 2% decline in the 10 year US treasury yield over the next 12 months could result in a 21% overall return (interest and capital). In short-core bonds not only offer attractive interest rates (between 4% and 5%) but also potential capital gains in a recessionary environment, which is very different to cash on which the interest would simply reduce in that environment. The opportunity to lock in yields at current levels looks compelling, even if bond volatility (pricing) is likely to remain elevated for some time.

Cash is never king over the long term:

Cash is important for short-term security and liquidity (up to 5 years) but if you can identify that your money won’t be needed for at least 5 years and ideally 10 years plus, then investing has historically earned a higher return. Equities (shares) are higher risk and more volatile, but have produced the highest returns and we see no reason to think that won’t be the case in the future. Bonds have returned more than cash but are lower risk than shares and therefore tend to offer a lower return than shares. However, right now they appear to offer very good value and also help to balance a portfolio of shares to reduce the overall risk.

Source: Bloomberg, Bloomberg Barclays, Dimson, FactSet, FTSE, J.P. Morgan, Marsh and Staunton ABN AMRO/LBS Global Investment Returns calculated from the Yearbook 2008, J.P. Morgan Asset Management. Equities: FTSE 100; Bonds: J.P. Morgan GBP Government Bond Index; Cash: threemonth GBP LIBOR (prior to 2008 cash is short-dated Treasury bills). Past performance is not a reliable indicator of current and future results. Data as of 15 November 2023.

Howard Goodship, chartered financial planner in Ringwood said:

‘Our role as financial advisers is to help clients achieve their financial objectives. Whether that includes investing surplus money to earn a higher return, keeping money in cash or buying an annuity for income, will depend on our client’s needs. Please don’t hesitate to contact us if you want to arrange a free, no obligation initial chat about your own financial matters and requirements.  Complete our booking form or contact your local Lonsdale Wealth Management financial adviser in  Wimbledon, Barnet, Leeds / Bradford, Stafford, Ware, Chippenham, Ringwood, Harpenden, St Albans.’

The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. The contents of this article are for information purposes only and do not constitute individual advice.

 

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