The Right Cash Balance – Three Principles for Successful Investing
Produced by Bloomberg Media Studios in partnership with Standard Chartered.
After a roller-coaster ride of a year, many investors are wondering if we have seen the bottom of the equity market – or if the current rebound is just a bear market rally. We sometimes worry so much about investing at the peak or catching the bottom that it distracts us from a more important task: making our money work harder for us to achieve our long-term financial goals.
There are very few sureties in investing, but at Standard Chartered, we believe three simple principles have stood the test of time and can be applied to the vast majority of investors: 1) not holding too much cash as a proportion of our net worth over the long-term, 2) staying invested with a long-term horizon, and 3) not trying to excessively time the market.
Not Holding Too Much Cash
Holding cash is not necessarily a bad thing, but holding too much cash over the long term can be detrimental to achieving long-term financial goals. The invisible hand of inflation hurts us slowly, but surely. The Economist’s Big Mac Index offers a useful, although imprecise, lens.
In 2000, a Big Mac in Singapore cost $3.20. Fast forward to 2021, and the price is now $5.90. This represents a more than 80% increase in the price of a burger, without considering any changes to its size, quality or ingredients. Of course, the impact of inflation on our household may vary, depending on what else we consume.
The table below illustrates the impact of inflation from the perspective of a Singapore dollar-based investor, based on its headline consumer inflation (CPI) basket. As we can see, the Singapore dollar has lost more than 30% of its purchasing power over the last 20 years.
A Dollar In the Future Is Worth Less Than a Dollar Today
While today’s economic environment could argue the case for holding a greater-than-usual allocation to cash, given that yields on cash are no longer zero and because of its safe haven appeal for those who believe risk assets could take another leg down, we don’t believe this is a prudent long-term approach.
For one, riskier asset classes tend to provide higher returns than cash in the long term, although it certainly does not feel like it this year. While there could be periods of underperformance, those periods have tended to be transitory and short-lived.
Second, while yields on cash may be positive in nominal terms today, they remain very negative on a real, or inflation-adjusted, basis. Riskier asset classes offer a better chance of beating inflation over a long horizon. Thus, staying too long in cash may be detrimental to earning sufficient returns to meet our long-term financial goals and objectives.
Besides the impact of inflation, holding cash can be “expensive” in other ways. Just ask the investor who was loaded up with cash and did not deploy it after the sharp market declines in March 2020, March 2009 and the summer of 2002. While the value of cash stayed intact, the opportunity cost from missing out on the rise in equities or bonds would have made this option (opportunity cost) extremely expensive. For investors holding more cash than usual, this should be accompanied by an active willingness to redeploy them into riskier asset classes at the soonest available opportunity.
Waiting Out Market Timing
The possibility of missing out on major market upturns is one of the key reasons investment advisors always tell investors to stay invested for the long term. The simple fact is that markets tend to go up more often than they go down. Reviewing S&P 500 Index returns over the past 50 years, the average duration of equities rising on a rolling basis was 4.5 times longer than the duration of equities falling.
Bull vs. Bear Markets for the S&P 500 Index, 1961-2021
Source: Bloomberg, Yardeni, Standard Chartered
Many wonder why that is the case. It is the same reason that has underpinned progress: human ingenuity, which has driven thousands of years of innovation, productivity and economic growth, has historically provided a strongly positive secular force for many investment assets. The stock market is one such asset. If this historical fact-based assumption is wrong, then we have a lot more to worry about than our investment portfolios.
Setting Emotions Aside
Another reason we should stay invested in the market is that no one can consistently catch market bottoms. Our emotions usually come in the way of making rational decisions at various points in a market cycle, whether we become despondent during market declines or euphoric during bull markets. Not many investors can effectively go against their fears and prevailing pessimism to deploy cash into markets during troughs.
Source: Standard Chartered
These three time-tested principles highlight the importance of having a disciplined plan that helps us invest regularly through the cycle, instead of trying to time the markets. Such an approach will make for a smoother ride as the cycle averages out, and be a less emotional experience as well.
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