by Lawrence Gillum, Chief Fixed Income Strategist, LPL Financial
After ten years of nearly zero cash yields, the Federal Reserve's (Fed) sharp increase in rates has raised cash rates, leading investors to place almost $6 trillion in cash accounts. And while cash yields are attractive, another attractive attribute for cash is the low risks associated with it. Cash has done a great job in recent years helping investors protect their portfolios from market turbulence. That was especially true in 2022, when both stocks and bonds experienced large drawdowns. But, with Fed interest rate hikes likely behind us, cash as an asset class may not be as important to portfolios as it was recently.
And we know those attractive cash rates arenāt going to last forever. Just as the aggressive rate hiking cycle took Treasury yields higher, interest rate cuts will eventually take all cash rates lower as well. However, with bond yields still elevated and likely to stay around current levels, investors can extend the maturity of their excess cash holdings by locking in current bond yields (not too far out on the curve, though). Locking into high-quality, intermediate-term fixed income can provide consistent cash flow and desirable income levels for years to come, regardless of what lies around the corner.
Moreover, bonds offer an optionality that you donāt get from cash. Although bonds and cash currently offer similar yields, bonds provide extra portfolio protection and the chance for price increases if the economy faces unexpected challenges, which cash does not offer. Additionally, over the past 40 years (ending April 2024), bonds have averaged a 6.1% annual return versus about 3.5% for cash. And bonds have been consistent outperformers. From January 1986 to April 2024, bonds had a better five-year return in 95% of the rolling five-year periods. In those few instances where cash did better, it only outperformed by less than 0.5%, on average. So, with cash rates likely to fall as the Fed cuts rates, bonds have demonstrated they do a better job than cash at helping investors grow their assets over the long term.
Bonds Tend to Outperform Cash Over Time
Trailing 5-year Annualized Total Returns
Source: LPL Research, Bloomberg 05/22/24
Disclosures: All indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results.
Investing is largely about setting up portfolios for future success. Ā We definitely consider cash as a valid asset class now, especially for investors with short-term goals spanning a few quarters to a couple of years. However, unless investors have short-term income needs, they may be better served by reducing some of their excess cash holdings and extending the maturity profile of their fixed income portfolio to lock in these higher yields for years to come. Bond funds and ETFs that track the Bloomberg Aggregate Index, along with separately managed accounts and laddered portfolios, all represent attractive options that will allow investors to take advantage of these higher rates before they disappear.
Copyright Ā© LPL Financial
