Cash is NOT Trash (finally!)
This just in: 2022 was not a great year for most people’s portfolios…
Historically a 60/40 portfolio (60 percent stocks and 40 percent bonds) was supposed to be a portfolio which weathered all kinds of market environments. Typically, stocks and bonds move in opposite directions of one another – taking some of the pain from a bad year in the stock market. However, 2022 was different. BOTH stocks and bonds were down significantly on the year. In fact, the bond market performance was the WORST YEAR EVER!
The reason for the awful performance of the bond market was rates increased dramatically during the year. The 10-year bond yield started 2022 around 1.6% - but ended the year with a yield of 3.9%. That kind of move is unprecedented but pales in comparison to moves in the 1 year. The 1-year bond started the year yielding less than .4% but ended the year yielding almost 5%!
Something that is not well understood is why rising rates decrease the value of existing bonds. The reason is simple: If you own a bond yielding 1 percent but there are bonds which mature around the same time which now yield 5 percent your bond is not attractive. To make the bond equally attractive to an investor the price needs to come down significantly on the one percent bond!
But lost in the discussion about terrible bond returns in 2022 is the fact that bonds (and cash) are now providing returns that we haven’t seen in more than a decade. For example, a US Treasury bond that matures in 6 months is yielding 4.9% currently! Cash equivalents such as very liquid money market accounts (not the ones at your local banks or credit unions) are yielding almost 4.5%! If you have money sitting in savings accounts at banks yielding less than 1% you are missing out. Banks are slow to raise returns on savings accounts because they make a LOT of money by paying low returns on these savings but loaning the money out at MUCH higher rates!
So how to navigate going forward?
1) Don’t try to time financial markets with your investing. Research over decades has shown that investors who invest and relax (as opposed to obsess) do MUCH better over time. Accept the fact you don’t know the future and even if you did you couldn’t successfully predict what financial markets will do.
2) Keep the maturities on your bond holdings short. What that means is you don’t need to tie up your money for a long time to get higher returns. In many cases cash equivalents like money market funds provide higher returns than do longer term bond funds. No need to go beyond average maturities for your bond holdings of a couple years.
3) Get your cash working for you! If your bank offers returns less than 4% you are getting taken advantage of. Stay away from locking money up in CD’s with early withdrawal penalties.
4) Use I-Bonds for limited cash balances. These federally insured bonds are limited to 10k for individual but provide a return higher than inflation. Currently they yield 6.89%!
Markets will move up and down significantly in the coming years – like they always have! Stay above the fray by accepting the fact you can’t predict the future but that’s OK. Investors have consistently been rewarded by exercising good behavior and navigating both good times and bad without feeling like they need to either sell or sit on the sidelines.