Many individual investors have recently demonstrated a strong appetite for various cash instruments (such as CD’s), especially as yields have been rising.
It is important to note, however, that it may not be the best idea to over-allocate to cash right now. Below are some key advantages and disadvantages to think about with respect to cash holdings today.
Also, on this topic, we were recently quoted in several Fortune magazine articles discussing some of the advantages and disadvantages of using CD’s and when they do and don’t make sense to use. Click here for the articles:
https://fortune.com/recommends/banking/cds-offering-higher-savings-rates/
https://fortune.com/recommends/banking/are-cds-worth-it-right-now/
Advantages of Bonds Over Cash
Given where cash interest rate yields are, what is the case for bonds right now? There are a couple of key advantages.
One is that when you purchase bonds and longer maturity fixed income investments, you are able to lock in a higher yield for longer. So, if you buy, a five-year bond or a 10-year bond, that means that interest rate will prevail over your holding period.
Another key advantage is that you do have some appreciation potential with fixed-income instruments, which is something you do not have with cash interest rate instruments. You don’t have principal volatility with a CD, but that goes both ways. You can’t have losses with a CD, but you can’t have gains, either. As we think of rates potentially going lower in the future, the fixed-income investor stands to benefit potentially from some appreciation in such an environment.
Advantages of Stocks Over Cash
What are some advantages of stocks over cash related investments such as CD’s?
Stocks have unlimited upside potential. When we look at the asset classes that have had the best long-range opportunity to outrun inflation, stocks have done that compared to other asset categories. This is important as you are thinking about your future and allowing for growth in your investment accounts. The main disadvantage of stocks, of course, is significant principal volatility potential. Cash accounts, in general, allow you to avoid risking any principal.
How should you divide right now between cash, bonds, and stocks?
In general, we believe that you should have a diversified mix of stocks, bonds, and (in certain instances) short-term investments. We also believe you should diversify your portfolio within those different types of investments. Setting and maintaining your strategic asset allocation are among the most important elements for long-term investment success. The right percentages and investment selections should be customized and depend on your personal situation and circumstances.
In thinking about protecting your investments and having your money work for you, it is crucial to think about some very basic principles:
*Diversification can help improve your returns and manage risk.
*You may avoid costly mistakes by using the correct risk level for your circumstances.
*Rebalancing is a key to maintaining risk levels over time.
The goal of diversification is to improve the probability of success for your investments, regardless of economic and market conditions. Choosing the right mix of investments and then periodically rebalancing and monitoring your choices can make a big difference in your outcome.
You should check your asset allocation once a year to determine if you need to rebalance your asset mix or reconsider some of your specific investments.
The value of a diversified portfolio usually proves itself over time. Many investors don’t realize their maximum investment performance potential because in rising markets people tend to chase performance and purchase ‘popular’ investments, and in a market downturn, they tend to move to lower-risk investment options. These behaviors can often lead to missed opportunities and reduced investment returns.
