High yields in money markets and CDs, alongside prolonged market uncertainty and risk, resulted in elevated cash allocations for portfolios this year. As tempting as 5% returns in cash may be short term, the mid- to long-term costs of missed opportunities in other asset classes mean investors should consider moving off the cash sidelines.
While returns remain attractive now for CDs and money markets, “the expected path of cash is down,” explained Natixis Investment Managers in a recent Portfolio Playbook.
When CDs mature and roll over in one year, interest rates are likely to be lower than current levels. This creates reinvestment risk alongside diminishing real returns.
A CD yielding 5% returns in a 3.5% interest rate environment only creates real returns of 1.5%. This number generally falls much lower than goals set for retirement and long-term financial planning.
What’s more, by staying invested in cash and cashlike investments, the opportunity cost can be significant. A one-year CD generating 5% returns takes an entire year to generate those returns. That’s assuming an investor doesn’t withdraw earlier, reducing the return potential.
In the meantime, stock returns offer the potential to generate similar returns in significantly less time. Even bonds offer notable yields right now; the 10-year Treasury currently offers a yield of 4.25% as of 6/14/24. A 10-year bond to maturity locks in the current annualized yield, regardless of the interest rate path.
Advisors should look at the long term when assessing stocks and the merits of investing even in periods of all-time highs. Attempting to time the market in case of correction could mean missing out on substantial growth potential.
“Although the market may be setting record highs, looking at the history of some of the largest stock market indexes such as the S&P 500 shows that record days are often followed by more record days,” Natixis noted. “In the long term, equity markets have historically increased 70% of the time and decreased only 30%.”
Positioning When Moving Out of Cash
A number of opportunities exist for advisors moving clients out of cash this year. For those looking to outpace inflation with a more offensive tilt to their portfolio, consider growth, small- and midcaps, and non-U.S. markets this year for equities. Within bonds, Natixis recommends looking to high yield, multisector, and bank loans for opportunities. Keep in mind credit risk with an eye toward cyclical growth sectors.
For those wishing to position portfolios more defensively this year, focusing on U.S. equities, large caps, and options-based strategies may prove beneficial. Within bonds, government and municipal bonds offer reliability and stability alongside a core-plus approach that includes high-quality corporate bonds. Natixis recommends seeking secular growth sectors and focusing on quality.
Advisors seeking to optimize and potentially free up more time for client-facing needs may consider outsourcing part or all of a portfolio to a third-party manager. This can provide diversified solutions that combine offensive and defensive core strategies for part or all of a portfolio. Natixis recommends actively managed portfolios that allow for flexibility in responding to changing market conditions. In addition, advisors should ensure portfolio objectives meet their desired risk/return client profiles.
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