Money Markets Vs. Stocks - What Should You Do Now?
We met an investor in Seattle last week who was simply paralyzed by the fear that the day that he invested any of his hard earned savings in stocks would be the day the markets begun to crash. Rather than suffer such a fate, this investor has stayed 100% in money market accounts for all of the past three years. Of course we pointed out how investors who have kept balances in cash have seen their inflation-adjusted wealth erode, and have missed out on the surprisingly strong 2009-2012 equity bull market.
How much return has this investor missed out on by being 100% in money markets? A balance of $10,000 invested in broad U.S. equities (S&P 500 Index) three years ago would now be worth $17,050. That same $10,000 invested in a broad bond fund (Barclays Aggregate Bond Index) would be worth $12,270, (and worth substantially more if invested in longer duration bonds). Even a bank CD would have generated several hundred dollars in interest. The $10,000 in his money market fund on the other hand has increased in value by a meager $27.33 over the past 3 years, and that was in Vanguard's Prime Money Market Fund (VMMXX), one of the better performing funds.
We were not so unkind as to spell out exactly how much return our colleague did not realize these past three years. That is not what matters now. What matters is what to do to prepare for the uncertain years to come. The fact is no one knows whether we face inflation or deflation, and markets can shift quickly and unpredictably. Bonds look more risky than in the past, and equities are inherently volatile investments. I am writing this from Japan, where stashing money under mattress has actually been one of the better asset allocation strategies for more than a decade. Deflation has meant that cash buys more hard assets, security prices have languished, and the yen has grown stronger.
Central bankers throughout most of the world have made it clear that savers are not likely to see any boost in money-fund returns for the foreseeable future, and savers can be sure that if there is inflation, it will take its full bite out of their cash.
So what did our colleague do? We pointed him to this diversified model portfolio -- for the funds that he did not expect to need to tap into during the next few years. The longer the timeframe, the more important it is to diversify risks and broaden into more and different securities. For example, at Portfolio Research we use eleven different asset classes including cash. Our allocation to cash currently ranges from 28.5% in our lowest-risk portfolio to 3.6% in our higher-risk RT15 portfolio. In Barron's recent survey of the 40 largest U.S. wealth managers' static asset allocation models, suggested allocations to cash ranged from 0% to 20%.
For his "rainy day funds" - money he may wish to access immediately for living expenses or emergencies - he switched to an online savings account. Money funds are no place for your emergency fund - park your emergency fund in an online savings account. While the top yields may still be below 1%, that is 50 times what you'll earn in most money funds -- and it's both FDIC insured and completely liquid. We consider these rainy day funds to be what we call "satellite investments". In this case having your cash ready and at hand is a priority, and generating no return is simply the cost you pay for convenience.
The other justification for keeping cash in a money fund is if you want the flexibility to put it back into the market at a moment's notice. But our friend in Seattle has been keeping his cash in a money fund waiting a market crash for a long time. When markets crash again, he will likely be too spooked afterwards to invest.
Perhaps you are waiting for stocks markets to crash? Or perhaps you are waiting for interest rates to get better? Rates are not likely to rise for a long time, so maybe it's time to put some of that money to work safely.
How much return has this investor missed out on by being 100% in money markets? A balance of $10,000 invested in broad U.S. equities (S&P 500 Index) three years ago would now be worth $17,050. That same $10,000 invested in a broad bond fund (Barclays Aggregate Bond Index) would be worth $12,270, (and worth substantially more if invested in longer duration bonds). Even a bank CD would have generated several hundred dollars in interest. The $10,000 in his money market fund on the other hand has increased in value by a meager $27.33 over the past 3 years, and that was in Vanguard's Prime Money Market Fund (VMMXX), one of the better performing funds.
We were not so unkind as to spell out exactly how much return our colleague did not realize these past three years. That is not what matters now. What matters is what to do to prepare for the uncertain years to come. The fact is no one knows whether we face inflation or deflation, and markets can shift quickly and unpredictably. Bonds look more risky than in the past, and equities are inherently volatile investments. I am writing this from Japan, where stashing money under mattress has actually been one of the better asset allocation strategies for more than a decade. Deflation has meant that cash buys more hard assets, security prices have languished, and the yen has grown stronger.
Central bankers throughout most of the world have made it clear that savers are not likely to see any boost in money-fund returns for the foreseeable future, and savers can be sure that if there is inflation, it will take its full bite out of their cash.
So what did our colleague do? We pointed him to this diversified model portfolio -- for the funds that he did not expect to need to tap into during the next few years. The longer the timeframe, the more important it is to diversify risks and broaden into more and different securities. For example, at Portfolio Research we use eleven different asset classes including cash. Our allocation to cash currently ranges from 28.5% in our lowest-risk portfolio to 3.6% in our higher-risk RT15 portfolio. In Barron's recent survey of the 40 largest U.S. wealth managers' static asset allocation models, suggested allocations to cash ranged from 0% to 20%.
For his "rainy day funds" - money he may wish to access immediately for living expenses or emergencies - he switched to an online savings account. Money funds are no place for your emergency fund - park your emergency fund in an online savings account. While the top yields may still be below 1%, that is 50 times what you'll earn in most money funds -- and it's both FDIC insured and completely liquid. We consider these rainy day funds to be what we call "satellite investments". In this case having your cash ready and at hand is a priority, and generating no return is simply the cost you pay for convenience.
The other justification for keeping cash in a money fund is if you want the flexibility to put it back into the market at a moment's notice. But our friend in Seattle has been keeping his cash in a money fund waiting a market crash for a long time. When markets crash again, he will likely be too spooked afterwards to invest.
Perhaps you are waiting for stocks markets to crash? Or perhaps you are waiting for interest rates to get better? Rates are not likely to rise for a long time, so maybe it's time to put some of that money to work safely.
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