Cash is king. At least for the moment.
Data Source: S&P Dow Jones Indices.
In the first quarter of 2018, short-term Treasury bills finished higher while both the S&P 500 and 10-Year Treasury bond declined. The greatest fear among many investors is that this trend will continue.
Is this a rational fear? How often has cash outperformed stocks and bonds historically? Let’s take a look.
We have annual data on stocks (S&P 500), bonds (10-Year Treasury), and cash (3-Month Treasury) going back to 1928.
Since then, cash has been the top performer in only 12% of calendar years. As your holding period increases from 1 year to 30 years, the odds of cash being king declines from 12% to 0%. The opposite is true for stocks, which have been the top performer in 63% of 1-year periods, 80% of 10-year periods, and 100% of 30-year periods.
Data Source: Stern.NYU.edu/~adamodar
If the odds of cash outperforming are so low, why hold it at all? Because you may not have a 20-year holding period or you may not have a high enough risk tolerance to hold through short-term volatility in stocks and bonds.
Cash is the only asset class that will guarantee you a return of principal in the short run. While bonds do pretty well on this front they will at times lose out to cash during periods of rising interest rates. We saw that in 2009, 2013, and thus far in 2018.
When was the last time cash outperformed both stocks and bonds in a single calendar year? Way back in 1994. Which means that investors under 45 have never seen it and investors over 45 probably don’t remember it.
Note: Calendar year total returns.
The trade-off from the safety that cash provides in the short run: lower long-term returns. Cash has annualized at 3.4% since 1928 versus 4.9% for bonds and 9.7% for stocks.
For investors with a 1-year holding period, accepting these lower returns is often the most prudent option, as both stocks and bonds could very well decline over that time period. But as your holding period increases beyond 10 years, cash makes less and less sense, as the probability of earning a higher return from stocks and bonds increases significantly.
