Cash Is Cool Again, but Bonds Are an Important Asset

Lawrence Gillum:

After over a decade of cash yields close to zero, the aggressive rate-hiking campaign by the Federal Reserve has pushed cash rates up and investors have taken notice by parking nearly $6 trillion in cash accounts. And while cash yields are attractive, another attractive option of cash is the low risks associated with cash. Cash has done a great job in recent years helping investors protect their portfolios from market turbulence. That was especially true in 2022 when both stocks and bonds experienced large drawdowns. But in this addition of the LPL Street View, with fed interest rate hikes likely behind us, we why cash may not be as an important asset class to portfolios as it has been recently.

Lawrence Gillum:

First, let me start by saying cash is no longer trash. Cash is absolutely back as a legitimate asset class again after leaving zero interest rate policies. In the past, the Fed has raised short-term interest rates to the highest level since 2007, which means cash rates are at the highest level since 2007. Moreover, the U.S. Treasury yield curve has been inverted since 2022, currently the longest yield curve inversion in history. Now, when the yield curve is inverted, shorter maturity, treasury yields are higher than longer maturity. Treasury yields, meaning at first blush, it may seem like cash and other short-maturity fixed income strategies are the way to go, and they are, but perhaps not for long-term investors because we know those cash rates aren't gonna last forever. Just as the aggressive rate-hiking cycle took treasury yields, higher interest rate cuts will take all cash rates lower as well.

Lawrence Gillum:

However, with bond yields still elevated and likely to stay around current levels, investors can extend the maturity of their excess cash holdings by locking in current bond yields. Additionally, there's an optionality that you get from bonds that you just don't get from cash. While current yields for bonds and cash are similar, bonds offer portfolio protection and potential price appreciation if an unexpected event negatively impacts the economy that you just don't get from cash. So for example, if we're wrong about the economy and it slows more than we think it will, the Fed may in fact cut interest rates more than markets are expecting, which would be beneficial to fixed income markets. And in the meantime, you can clip coupons and generate attractive income with bonds. Finally, over the past 40 years, bonds have averaged around 6.1% annual return versus about 3.5% for cash. And bonds have been consistent outperformers from January, 1986 to April, 2024, bonds had a better five-year return in 95% of the rolling five-year returns.

Lawrence Gillum:

In those few instances where cash did better, it only outperformed by less than a half a percent on average. So with cash rates likely to fall as the Fed cuts rates, bonds have done a better job than cash at helping investors grow their assets over the long term. Investing is largely about setting up portfolios for future successes. And while we certainly think cash is a legitimate asset class again, particularly for those investors whose time horizon is measured in quarters or even a few years. But unless investors have short-term income needs, they may be better served by reducing some of their excess cash holdings and by extending the maturity profile of their fixed income portfolio to lock in these higher yields for years to come. Locking in high-quality, intermediate-term fixed income can provide consistent cash flow and desirable income levels for years to come. Regardless of what happens around the corner, bond funds and ETFs that track the Bloomberg Aggregated Index, along with separately managed accounts and ladder portfolios, all represent attractive options that will allow investors to take advantage of these higher rates before they disappear. Thanks for listening.