Broker Check

Mistakes in Client Thinking Part 3 - Moving Everything to Cash

December 05, 2023

This is the 3rd in our series of common investment mistakes. One of the things that fascinates me is neuroscience and how our minds work as humans. Combining neuroscience and finance is the field of behavioral finance. It is the psychology of money.

Emotions are essential to the human experience, making our lives rich and fulfilling. However, emotions can also present challenges. In addition, we all have biases and blind spots, which can lead to fallacies in our thinking. As a professional, I acknowledge these limitations and strive to remain humble, recognizing that I do not have all the answers. I consider my thoughts through the lens of my thinking constraints.

The third and final mistake we commonly hear from clients is, “Why don’t I just move all my money to cash?” In light of significantly higher interest rates, lately, we have had clients tell or ask us, “With interest rates of 4-5%, why don’t I just lock in guaranteed rates with a CD for X years?”

First, I can understand this appeal, especially with the bear market and volatility with stocks and bonds over the last several years. As I tell all clients, you are always in charge. It is your money, and I respect the decisions you make and the autonomy you have. However, as a fiduciary, I do not recommend you move your money all into cash. Here are three reasons why:

(1) You Cannot Time the Market Effectively 100% of the Time - We have emphasized this in other blogs. Many people are attracted to the presumption that I will put my money in one asset class and then move it to another at the right time. However, the chance to time the market and move from one asset class to another 100% of the time is virtually impossible. The top money managers in the world have little to no success doing it. It is statistically improbable for the rest of us, especially if we do not have a system and are just doing it out of emotion or what we hear in the news.

This is why we believe in the bucket plan, where you diversify your assets between the three buckets and the time frame when needed. The bucket is almost 100% cash for needs within the next year. Soon bucket is also stable for spending needs within the next 2-10 years and made of cash, bonds, and guaranteed annuities. The Later Bucket is for ten years or more and includes stocks. As we have discussed, there is no better long-term way to invest than in the ownership of the best-run companies. The fact that their value can drop 50% should not discourage us if we are holding in buckets that we will not use for ten years or more.

(2) Cash makes us feel good, but long-term does not keep up with inflation 

- We need cash in the short term to exchange it for products and services. However, inflation is another certainty that happens over time with death and taxes. Over the long term, the cost of things will go up. The challenge with cash is that it is a very poor tool long-term to keep up with inflation. The purchasing power goes down over time. How I keep it straight: Five and Dime’s still existed with Woolworths and Ben Franklin when I was a kid. A nickel and dime used to be a way to buy things cost-effectively. Then, as I got older, Dollar stores came into existence where everything cost $1. Now, there are Five Below stores where everything costs $5 or less. Inflation usually is like the extra pounds we get around the holiday. It usually comes up slowly to where we now accept that things cost more. The cost of gas from my young adulthood gradually rose from a dollar to the current value of $3-4 per gallon. It did not happen all at once. Cash makes us feel good but is a terrible long-term hedge for inflation.

The slide that is shown here shows us how interest rates of cash and money markets have their stated return and actual purchasing power. Looking at the last column, you can see how cash barely keeps up or reduces your spending power.

(3) The Best Investment Swings Back and Forth on Year to Year Basis, but long-term stocks and bonds pay more. This next slide was eye-opening to me. It shows how, three years after money market rates peak, the subsequent returns of the stock market. You can see that over the last 20 years, whenever money market rates peak, the returns in the stock market over the next three years are mid to high teens in percentage.

When you think of this, it makes sense. The Federal Reserve has aggressively raised interest rates over the last several years to combat inflation, resulting in negative stock and bond returns. The Federal Reserve has recently communicated that they will likely pause rate increases and possibly lower them over the next two years. Whenever that happens, the stock market tends to do well. Whenever it looks like interest rates might increase, stocks become volatile.

Over the long term, the risk premium improves stocks and bonds. Investors are compensated for the increased volatility of certain investments, such as stocks, compared to others. Once again, it validates one taking a time-segmented or bucketed approach.

In closing, wanting to move 100% to cash is appealing. It is understandable if you have thoughts of doing it. As fiduciaries, we do not recommend that you do it. It is too hard to time our decisions and think we can effectively determine what the best asset classes are from year to year. If you need to talk or want to create a plan, we can help.