“The horizon has been defeated by the pirates of the new age.” – Jack Johnson, The Horizon Has Been Defeated
In the spring of 2002, I heard the name “Jack Johnson” many times before being officially introduced to his music. The Monday open mic nights at The Phyrst – a classic (literally underground) PSU Irish pub – in State College, PA, were packed, making for an unbelievably fun semester. After my sets that typically involved a couple of original tunes and a Sublime cover, people would routinely ask if I’d heard Jack Johnson’s music (I hadn’t) and encourage me to check him out. In my defense, Jack Johson wasn’t playing on the radio, and I couldn’t just pull up his songs on my phone or even my computer. Eventually, my friend Elaine – a rare beauty among my engineering classmates – lent me a burned CD of Brushfire Fairytales, and I quickly realized what I was missing. I played that CD endlessly (until she made me give it back to her), and Jack Johnson has starred in my life’s soundtrack ever since.
During that vital semester, I transitioned from a basement guitarist to a public performer, cutting my teeth on stage and becoming a small part of the State College music scene. Thankfully, a local band, The Carbombs, showed up at one of our house parties, and we ended up jamming together. Without their encouragement, I may have never performed in public. Thus, that chance encounter likely wholly altered the trajectory of my life, including my career, where I live, and who I married. It’s the little things in life. Those are stories for another day, but we’ve now set the stage for today’s discussion of time horizons and objectives (of course, with some Alts tie-ins) and why these things matter more than ever in this environment where investors are earning about 5% on their cash. Here we go!
It starts with your goals
I still feel a lot of nostalgia and gratitude for those very formative few months: Our time horizons were short, living for the moment and being allotted only three songs by Tommy (The Phyrst’s music czar and local musician) to leave our mark on the crowd. When calling into the bar at precisely 4pm each Monday for a time slot later that evening, you had to choose wisely: too early meant a sparse, sober audience; too late could result in overly libated patrons or a thinning crowd opting for food or sleep. For me, the “Goldilocks” slots were around midnight. But then, that’s because my objectives were to play for the most people at the optimal level of drunkenness.
Other open-mic timeslots may have better-suited performers with goals that differed from mine. For example, perhaps someone wanted to dip their toe in the waters of performing, and they were most comfortable only playing for a few people. To each his own, as they say.
A dangerous mindset
As advisors, we’ve repeatedly received some form of the question – with rates this high, why don’t I just invest in cash? – for over a year, ever since the Fed hiked interest rates to levels meaningfully above zero. And, lest you think you’re immune to this mentality, it comes in various forms, like the following:
- If stocks only pay 4% dividends, cash is paying me 4.5%, and I can get 5% in a 2-year US Treasury, who needs stocks?
- I’m just going to hold cash for a while, collect my interest, and keep an eye on the market. Maybe I’ll buy some equities when things “feel” better. Makes sense, right?
- A recession is coming, so I’m just going to hold high-quality bonds and treasuries until the market declines, and then I’ll add some to the market.
Have any of those thoughts crossed your mind? It’s okay and probably natural if so. HOWEVER, if after considering those options, you still feel they are anything but complete nonsense – then I’m here to remind you of why that’s the case!
The short answer is: “because of objectives and time horizons”
It feels strange to type this, as it’s (hopefully) so obvious: short-term investments are for short-term goals, and long-term investments are for long-term goals. Cash is short-term. Stocks are long-term. Bonds and Alts can be appropriate across a spectrum of timeframes, depending on the durations, quality, strategies, and liquidity involved.
So, I have faith in you, the reader, that you already know the answer to the question, “Should I invest my long-term retirement money in cash?” I think people get that they may be mismatching timeframes of objectives and solutions but that they struggle a bit more in ascertaining exactly why that’s true. And, as is often the case when investing, fear plays a central role in this discussion. So let’s shed some light on all of that.
Cashing in
For those who need to hold cash, I agree it feels good to earn meaningful interest again. For years, reminiscing about high-yield savings accounts paying 4% – commonplace before the financial crisis – felt akin to speaking about dinosaurs. But whether cash yields 4% or 0% is essentially irrelevant to the core of the matter, which is that cash is for short-term objectives.
Cash is a prudent option whether there’s a significant expense on the horizon 6-12 months from now or simply parking cash reserves (for which people often target 3-6 months of living expenses). Other short-term options could be considered, like money market funds, CDs, or even short-duration high-quality bonds (if a person is willing to stomach the possibility of price volatility). That is a question of deciding between various short-term options, and you are encouraged to do so! They all have different attributes (e.g., FDIC coverage, interest rates, liquidity, principal protection, penalties, etc.) that will lead to an optimal choice for a particular investor in a particular situation.
Whether interest is earned or not, the purpose of short-term instruments is to be available when needed (aka “highly liquid”) while not subjecting us to the potential of selling at a significant loss at that time.
Stop, drop, and roll..to your local bank
With the above short-term needs in mind, once we consider investments with a) more significant risk of volatility in value, b) liquidity restrictions, or c) both, it’s easy to see why they aren’t appropriate for our short-term goals. That short list includes:
- Stocks: usually highly liquid but potentially very volatile.
- Bonds: short-term, high-quality bonds may work (2022 is a great cautionary tale of when they may not), but especially once the duration of bonds starts getting longer than the target timeframe of when the money will be needed, it risks principal impairment when it’s time to sell the bond to spend the cash on your goal.
- Alts: sometimes completely illiquid and potentially volatile. An exception could be certain low-volatility, daily liquid strategies, but you must do your homework to avoid a minefield of “things that work until they don’t.” Trust me that it’s more enjoyable to know your cash is available when needed than to be left with nothing but a horror story of how an expectedly “safe investment” blew up.
Regarding the most crucial element of planning for short-term goals (i.e., principal protection), your bank account is your friend – the challenge is keeping FOMO at bay.
Stocks (and most Alts) for the long run
The whole crux of this discussion is the opposite of the above situation: We know we shouldn’t use stocks, Alts, or longer-dated bonds for short-term goals, but why shouldn’t we use cash for long-term needs? It’s because of a mismatch in attributes. What we need from long-term investments – in very general terms – is to grow at a rate that is at least greater than inflation. Holding cash is a sure way to fail at that objective! And even if cash yields are temporarily outpacing inflation (arguably our current situation), that still doesn’t make it an advisable long-term holding.
The only chance of return on your cash is the interest rate. It offers no opportunity for appreciation. The interest is also taxed as ordinary income, which is inefficient. As was laid out in our original client questions, some people contend they can hold cash and hope the market provides a better time to invest. That assumes you’re essentially a magician and can time markets, which any prudent advisor shouldn’t pretend anyone can ever do consistently. More importantly, attempting to time markets is playing with fire, as it puts investors in a position to commit the worst sin of long-term investing: being on the sidelines while markets run away from them.
From a long-term perspective, equity markets (e.g., the S&P 500) have trended upward. There are levels it has never returned to. The S&P 500 traded at around 350 in 1982. It trades at about 4500 today. Someone trying to time the market back in 1982 would still be waiting for their entry point, while the market has gone up 13x – and that ignores dividends. It’s a safe bet that holding cash wouldn’t have allowed them to adequately grow their nest egg or garner the income needed to fund their lifestyle. The fear people have is investing in the market just before a period of significant drawdown. It’s an understandable gut reaction, but the arguments amounting to volatility avoidance don’t hold water in the context of proper financial planning.
Stocks and select alternatives (e.g., dividend-growth stocks and real estate) can allow for price appreciation, consistent income, growth of income, and tax efficiency that cash cannot even remotely contend with. And that is the stuff long-term dreams are made of!
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
