Cash Is Costly Over the Long Term
Thursday, August 8, 2013
Charles Rotblut, CFA
AAII Journal Editor

AAII Resources

The Role of Risk-Free Assets
Cash enables spending and can moderate downside risk.

Dividing Between Stocks, Bonds and Cash
Learn how to incorporate a mix of assets.

Basic Truths About Asset Allocation
Financial experts give guidance about portfolio management.

AAII Discussion Boards
How are you allocating for your long-term goals?

Most Popular AAII Articles

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 39.5%, up 3.9 points
  Neutral: 33.9%, down 5.5 points
  Bearish: 26.6%, up 1.6 points

Long-term averages:
  Bullish: 39.0%
  Neutral: 30.5%
  Bearish: 30.5%

Take the AAII Sentiment Survey »

Many Americans believe “cash investments are the best way to invest money not needed for more than 10 years,” according to a new survey by More than one in four Americans (26%) favor cash as the best long-term investment, choosing it over real estate (23%), gold or other precious metals (16%), stocks (14%) and bonds (8%).

There was an income component differentiating the results. Those earning six-figure salaries preferred stocks (34%) and real estate (32%), while those earning less preferred cash (29%), real estate (23%) and metals (18%). There was also a bit of a gender gap, with women having a greater preference for cash (30% versus 21%) and men having a greater preference for stocks (18% versus 11%).

What’s more notable about the results is the number of respondents in every demographic category who chose an asset other than stocks for long-term investing. Clearly, there is risk aversion at play. This is not surprising given the two bear markets that have occurred over the past 13 years and the still-lingering effects of the last recession.

There is also, however, a lack of understanding about inflation and the historical returns of stocks. Over the long term, inflation significantly reduces purchasing power. (Purchasing power is your ability to buy goods and services for a certain amount of cash, such as a dollar.) Even at the current low levels—the most recent Consumer Price Index data calculated the 12-month inflation rate as being 1.8%—investors are guaranteed to lose out by holding cash over the long term.

For example, let’s assume a scenario where interest rates and inflation stay unchanged from current levels for the next 10 years. (Yes, I know the odds of this happening are extremely low.) You save $10,000 now in a cash-equivalent vehicle at an annualized yield of 0.67%, which says is the current national average for one-year CDs. Ten years from now you incur an expense in an amount equivalent to $10,000 in today’s dollars. By solely investing in cash, you will face a $1,260 shortfall in savings. (At a 1.8% inflation rate, the cost of the expense will grow to $11,950, while your savings will only increase to $10,690.) If inflation accelerates, the risk of an even bigger shortfall increases as well.

This is not to say stocks are riskless. During a 10-year period, they can fall in value, as large-cap stocks did from 1999 through 2008. The long-term data, however, suggests the odds favor investing in stocks. Since 1926, large-cap stocks have realized positive returns 74 out of 78 10-year periods. Small-cap stocks have fared even better, realizing positive returns during 76 out of 78 10-year periods, according to calculations published in the 2013 Ibbotson SBBI Classic Yearbook.

Treasury bills, which are considered to be a cash-equivalent investment, have fared better on an absolute basis. They realized positive returns during all 78 10-year periods calculated by Ibbotson. On a relative basis, however, the performance wanes greatly. Only once did Treasury bills realize a higher 10-year return than large-cap stocks, small-cap stocks, intermediate-term government bonds, long-term government bonds or long-term corporate bonds. The period was 1965 through 1974, and Treasury bills barely outpaced inflation (5.43% versus 5.20%) during it.

In contrast, large-cap stocks and small-cap stocks realized the highest returns out of the group 20 times and 45 times, respectively. Though gold and real estate were excluded from the calculations, I don’t think their inclusion would have changed the results much since stocks have historically outperformed both of them over long periods of time.

None of this is to say you shouldn’t hold any cash. A certain amount of savings is needed for emergencies, planned upcoming expenses, retirement withdrawals and anticipated near-term portfolio adjustments. However, for money not needed for at least 10 years, cash is costly, both in terms of the loss of purchasing power and in terms of the loss of wealth you could realize by maintaing a significant allocation to stocks as part of a diversified portfolio.

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The Week Ahead

Second-quarter earnings season will start to wind down next week with fewer than 20 S&P 500 members reporting. Included in the group are Dow Jones industrial average components Cisco Systems (CSCO) and Wal-Mart Stores (WMT). The two will report on Wednesday and Thursday respectively.

The economic calendar is packed. July retail sales, July import and export prices and June business inventories will be released on Tuesday. Wednesday will feature the July Producer Price Index (PPI). The July Consumer Price Index (CPI), the August Empire State manufacturing survey, the August Philadelphia Fed survey and July industrial production and capacity utilization will be published on Thursday. Friday will feature July housing starts and building permits, the preliminary August University of Michigan consumer confidence survey and revised second-quarter productivity.

Atlanta Federal Reserve Bank President Dennis Lockhart will speak publicly on Tuesday.

AAII Sentiment Survey

Optimism rebounded in this week’s AAII Sentiment Survey, as neutral sentiment pulled back from last week’s eight-year high.

Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 3.9 percentage points to 39.5%. The rise puts bullish sentiment slightly above its long-term historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged, pulled back by 5.5 percentage points to 33.9%. Even with the decline, neutral sentiment is above its historical average of 30.5% for the 11th consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 1.6 percentage points to 26.6%. Though the fourth consecutive weekly increase, pessimism is below its historical average of 30.5% for the sixth consecutive week and the 11th time in 14 weeks.

Neutral sentiment pulled back after reaching its highest level since April 14, 2005, last week. A bit more enthusiasm for stocks, differences in which AAII members responded to this week’s survey and a bit of reversion to the historical average all were contributing factors.

The current levels of bullish and neutral sentiment imply individual investors are not excessively optimistic about the short-term direction of the markets, although the majority is not expecting stock prices to be lower six months from now either. Some individual investors are encouraged by signs of continued economic growth, sustained earnings growth and the length of the current rally. Others, however, are concerned about prevailing valuations, the slow pace of economic growth, interest rate uncertainty and a lack of progress on key issues by Washington politicians.

Since we are in the middle of summer, this week’s special question asked AAII members how closely they monitor their portfolios while on vacation as compared to when they are home. Responses fell into three categories: about the same (38%), less often (26%) and don’t monitor (29%). Some AAII members said the frequency at which they check their portfolios while on vacation depends on their access to the Internet. Other respondents said the point of a vacation is to get away from everything.

» Take the sentiment survey

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