Cash Is a Strategic Asset Class

The following is a guest post by Rob Bennett of A Rich Life. While it is not the intention of this site to present and offer investment advice to visitors, Rob offers a conservative approach that may be of value to anyone who is in a career change, debt reduction, or other type of financial transition, and represents a refreshing approach that offers a counter to the prevailing financial culture that recommends heavy and permanent positions in stocks?an investment class which is more risky than most people commonly understand.–Kevin Mercadante

Many people believe that stocks are always the best asset class for middle-class investors. It?s not so and I can show this with numbers.

The price that you pay for stocks obviously affects the long-term return you obtain from them. But have you ever gone to the trouble to check how much overpricing affects the return obtained? I have, and the results of my investigation were eye-opening for me.

I have a calculator at my web site called ?The Stock-Return Predictor? that uses a regression analysis of the historical stock-return data to reveal the most likely 10-year annualized real return from the purchase of a broad index fund made at any of the various possible valuation levels. At the top of the insane bull market, stocks were priced at three times fair value. Can you guess how much that amount of overvaluation brought down the ?usual? return on stocks (6.5 percent real, or about 10 percent after factoring in inflation)?

The answer is —

The most likely 10-year return on an index fund purchased in January 2000 was a negative 1 percent. Yikes! That?s not a one-time negative return. That?s a negative return (on average) every year for ten years running.

So much for ?Stocks for the Long Run?! And ?Buy-and-Hold?! And ?Timing Never Works!? And all the other cute marketing slogans pushed on middle-class investors by The Stock-Selling Industry!

Those open to looking at safer asset classes were not doomed to a negative long-term return on their retirement money. Treasury Inflation-Protected Securities (TIPS), an asset class that comes with a government guarantee attached, were paying at the time 4 percent real.

Do that math. TIPS were likely to beat stocks by 5 full percentage points of return for 10 years running. The investor who moved from stocks to TIPS when stock prices went insane set himself up for achieving retirement many years sooner by doing so.

Why then weren?t we told? Why did we hear only the pro-stock marketing slogans?

Nobody makes much money promoting TIPS or other cash-like investment classes. The ?experts? in the investing advice field HATE cash. No commissions. No acceptance into the ?Experts? Club. No appeal to the Get Rich Quick impulse lurking within each and every one of us that tempts us into ignoring price when choosing our investment classes.

It gets better (or worse, depending on your perspective).

The investor who moved to cash when stock prices went insane has far more in his portfolio to invest in stocks now that they are again priced reasonably. I also have calculators at my site allowing you to determine how much of a difference valuation-informed investing makes. The short version of the story is — investing rationally rather than going along with the marketing slogans (which, like all marketing slogans, appeal primarily to the emotions) permits you retire at least five years sooner.

If only there were commissions paid to those who recommend investing in cash at appropriate times!

But wait. It gets even better (or worse) yet.

Rational cash investors are today ahead of emotional stock investors by a significant margin. But that margin is going to grow larger and larger over the years. Do you know how they always tell us that saving a dollar produces huge financial gains in the long term through the magic of compounding? It works that way with avoiding stock losses too. Every dollar you protected by moving to cash when stock prices went insane is going to be multiplied many times over in coming years through the magic of compounding returns.

Cash is a strategic asset class. That?s what it comes down to. Cash isn?t just for sissies anymore. Cash is for those who don?t like to see their portfolios wiped out by the dubious investment advice of glorified salesmen. Cash is for aspiring early retirees. Cash rocks!

Stocks rock too. When purchased at reasonable prices, stocks offer a long-term value proposition far better than cash. Stocks are great. Stocks are the middle-class investor?s best friend. I love stocks.

But I ain?t one of those ?experts? working on behalf of The Stock-Selling Industry. I get a kick out of cash too.

Rob Bennett is author of the A Rich Life blog and co-creator of ?The Stock-Return Predictor,? a calculator that reveals the long-term value proposition of stocks purchased at any of the various possible valuation levels.

2 Responses to Cash Is a Strategic Asset Class

  1. The majority of my liquid assets is in cash (70%) making 4.2% / annum. It?s nothing sexy, but I?ve built THE NUT already so even at 4.2%, I?m earning over 20K/yr in interest income. I?m happy with that guaranteed income, and am excited to continuously add to it for the next 8-10 years.

    I don?t want to put more money in the stock market b/c I believe that?s what my 401k is for. If you?ve worked for 10 years, you may have probably 150-200K in your 401k given the 15K/yr contribution, dividends, + employer contribution an profit sharing. And that is post correction. Hence, to add another several hundred thousand to the stock market just doesn?t seem prudent.

    Once the cash nut is built, it?s good enough. Imagine having $1billion in the bankin?. earning $40mil/yr in interest income is good enuf!


    comment by RB @ RichBy30Retireby40
    Tuesday, July 21, 2009 @ 7:25:43 AM

  2. Rich–Not many people think of it in the way you’ve laid it out, but you make a strong point. You can bet a lot of stock market investors were wishing they did something similar a couple of years back when the market was hovering around all time highs, just before the plunge.

    When Rob ran the idea of this post by me I really hesitated because of the investment orientation, but his advice was solid for anyone with the financial markets being as volatile as they have been.
    comment by Kevin (admin)
    Tuesday, July 28, 2009 @ 12:26:02 PM

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