In 2018, the S&P 500 has gained 7.0%, the Dow Jones has a return of 6.7% and the Nasdaq has gained 10.4% through Oct. 8, 2018. These returns are high enough to draw many investors to the equity market. However, yields are also on the rise as the economy maintains strength and the Federal Reserve is in policy-tightening mode. This type of environment can make the decision between cash and stocks even more difficult. Let's take a look at some of the important risk factors to consider when investing in cash versus stocks and managing risk optimization in a portfolio.
Things to Remember
Markets go up and down. They always have and always will. While it may be stressful to see your portfolio go down, keep in mind that from Jan. 2, 2009 to Oct. 8, 2018, the S&P 500 went up 249%. Since it's difficult to predict which way the market will go, market timing is not always a good idea. Instead, you could allocate some of your portfolio to index funds. In order to capture market returns with index funds, you could take advantage of dollar-cost averaging instead of keeping cash on the sidelines. (For more, see: Dollar-Cost Averaging Pays.)
With that said, one of the keys to growing a portfolio is minimizing your losses. Market timing with cash and strategic stock purchases can be vital to keeping your losses as low as possible. This brings us to what to watch for in the market so you can try and minimize your losses while still putting yourself in a position to take advantage of the next stock market growth phase.
Volatility is a constant factor when investing in stocks. For the one-year period through Oct. 2018, the VIX Volatility Index has a gain of approximately 52%. A changing global trade environment is ever present, leading to a lot of the market’s volatility. Corporate earnings have been good but always lead to volatility while gross domestic product numbers remain above 2% but are still fluctuating. As a result, stock volatility can be more than many investors want to handle on a daily basis.
Monetary policy is the second factor to follow along with volatility. It can greatly influence the market’s investment demand and how investors allocate their money. Low policy rates help to stimulate borrowing while higher rates cause more investors to save. Since 2015 when the Fed raised the federal funds rate for the first time in seven years, the federal funds rate has gone from 0.25%-0.50% to 2.00%-2.25%. Thus, the higher base rate has increased interest in cash investments.
Corporate profits are steady and companies are coming off a period of borrowing stimulus. This is fueling broader corporate profit growth across the market with volatility, but making stock investments attractive generally. As the global trade war thickens, this profile may change, and trade definitely influences the global internationals. Alternatively, many of the global internationals are also top dividend-paying companies, which affects income investors deciding between stocks and cash as well.
Cash or Stocks?
Investors opining cash versus stock investments in the current environment will want to closely watch the change in base rate cash levels. High-yield savings accounts are averaging approximately 1.90% and the 10-year Treasury is consistently tracking at around 3.25%. Thus, most investors are increasing their cash levels to take advantage of the risk of gains. That said, below are some additional considerations for cash versus stock in 2018 and beyond.
- Are stock profits stable or growing? Many may consider gas companies a great buy right now because they have fallen so far. However, the market may not stabilize and improve as fast as some expect.
- Are dividends stable? Dividends are a large portion of the total return you get on a stock. If a company has a dividend that is stable and they have a high dividend payout ratio, then you might consider buying it. If the price of the stock is not going to go up, at least you get the return from the dividend.
- Am I OK owning this stock for at least five years given the current market conditions? In other words, do you have enough conviction in the stock’s value or growth prospects to believe in its ability to weather the market’s volatility.
The amount of money you are willing to bet on cash versus stocks will also likely be influenced by your risk tolerance and investing goals. Investors who need funds for emergencies or are hoarding cash for luxury purchases will want to capitalize on any increases in liquid cash investments. Investors with a higher risk tolerance and longer-term horizons for investing can potentially take more bets in dividend, value and high growth stocks.
The Bottom Line
The perspective on the market will change depending on the investment professionals you follow, but most investment advisers believe that the U.S. economy has been in an expansion phase since around June 2009 when the market hit Financial Crisis lows. While returns following the Financial Crisis are not expected to repeat themselves again, the expansionary characteristics of the market have many investors generally bullish in 2018 and through the near term. However, the rising base rates of cash investments also have many investors pulling their investments to cash. Overall the current environment can be an opportune time to become more aware of liquid cash options while still feeling confident in the potential returns of equities.