Cash is king… Or is it?
- Market volatility isn’t the surprise, it’s the speed and magnitude of change.
- Cash is often one of the worst performing assets.
- Holding too much cash has its own set of risks.
“It was obvious that interest rates were going up and that (insert top performing strategy) would be the best investment approach for this environment.”
I’ve been in the financial services industry for nearly 30 years now, and every single time, following a significant market event, I hear a couple of “it was obvious” statements. And sometimes, to an extent, I agree with them. There are often signs (much easier to spot after the fact – hindsight is, after all, 20/20) that something is about to happen.
For several years, we’ve been educating investors on interest rate cycles and the fact that interest rates could not remain at historic lows forever. Furthermore, our fixed income investment strategy reflected that belief, focusing on investments with lower duration (interest rate sensitivity) risk.
Yet the speed and the extent of the market event always catches everyone by surprise. Put another way, it’s not the direction that things are going that is unexpected, but rather more the velocity and magnitude of the event. It is this surprise that tends to lead to higher market volatility.
Why don’t I have more cash?
When major market corrections happen, one question is often asked – why didn’t I have more cash to protect me? The truth is cash is rarely a top performing asset class. In fact, it’s often one of the worst.
In contrast, a well-diversified portfolio is always going to perform near the middle of the pack from a return perspective – this is illustrated in the chart below. The portfolio is a blend of all the asset classes, so mathematically, it can’t do worse than the worst performing asset class and it can’t do better than the best.
Generally, during most market events, a well-diversified portfolio, comprised of equities and fixed income, provides some peace-of-mind as fixed income typically provides a buffer from equity volatility. Historically, traditional equities and fixed income tend to take turns on the performance leader board. It’s why this approach works most of the time.
But once in an infrequent while, cash does rise to the top.
Asset class winners and losers - January 2007 to June 2022
Graph illustrating calendar year returns of different asset classes from 2007 to June 2022. Best and worst performing assets class vary year-to-year. Treasury bills, a proxy for cash, historically performs relatively poorly. A diversified portfolio always performs in the middle of the pack.
What should you do? Refocus on your goals
So, should you be going to cash? Maybe. It depends on the goals you’re trying to achieve – the reason you’re investing in the first place.
The fundamental questions we must ask are:
- Have your goals changed?
- Have your personal circumstances changed?
- Has your “risk appetite” changed?
If the answer to all these questions is no, assuming you have a diversified portfolio designed to meet your goals, then history suggests riding the volatility wave and staying the course.
During times of market volatility, your MD advisor* can review your plan to ensure you’re still on track to meet your goals or make necessary adjustments. In most cases, portfolios and investment plans have been built with market volatility in mind, even for those approaching retirement.
Drawing income from a portfolio in a down market is not ideal. But one must keep in mind that the portfolio needs to generate growth for another 20-to-25 years (in most cases) to fund your retirement goals (the Medicus Pension Plan, expected to launch next year, can help with this problem by providing predictable retirement income to Canada’s physicians). This leads to my next point…
It can be risky going to cash
I get it, it would feel good to be in cash right now. However, the decision to deviate from a diversified portfolio and allocating a significant portion to cash, introduces a different type of risk – the risk of not being able to achieve your long-term goals.
Moving to cash is essentially a form of market timing. To benefit your portfolio, it is critical that you get two things right – when to exit the markets for cash and when to get back in. To call this a challenge is an understatement, especially trying to time your reentry. I’ve seen it many times, the damage to one’s portfolio caused by sitting on the sidelines, waiting for irrefutable signs that things are turning around, just to miss the initial phase of the recovery, which usually comes fast and furious.
The graphic below demonstrates this. An investor with an initial investment of $100,000 that got out of the markets in early 2009 (the bottom of the 2008 financial crisis) and got back in 12 months later, would be approximately $75,000 behind someone who stayed invested the entire time, 13 years later. Sure, this is way better off than someone that would have stayed in cash the entire time, but $75,000 is a significant amount of wealth on a $100,000 investment.
The importance of staying invested
Graph comparing the growth of three $100,000 portfolios from 2007 to June 2022. The first portfolio stays invested in the markets the entire time. The second portfolio exits the markets at the bottom of the 2008 financial crisis and reenters the markets 1 year later. The third portfolio exits the markets at the bottom of the 2008 financial crisis and stays in cash. The portfolios grow to $230,611, $156,940 and $74,570 respectively.
Let’s not forget about inflation
One last point about cash, particularly timely as central banks continue to raise interest rates to combat elevated inflation, is that it’s pretty certain that returns won’t keep up with the cost of living increases over the long term. Despite the positive absolute returns, too much cash will ultimately lead to the erosion of the purchasing power of your money.
Now, I recognize that weathering down markets is easier said than done. Market volatility, after everything we’ve been through over the past three years is, for many, another source of unneeded stress and worry. It’s human nature to want to take action to make the discomfort go away.
But it’s been proven more often than not that refocusing on your goals, having an objective assessment of the impact of market events on your ability to reach those goals and being able to filter out media noise will benefit the long-term returns of your portfolio – the probability of success is much greater than attempting to time the exit and reentry into financial markets.
If you have questions about your portfolio or would like to discuss current market events, I highly recommend speaking with your MD Advisor. Helping with the emotional aspects of investing is just one of the ways she or he can add tremendous value.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.