The allure and illusion of high returns on cash in the short-term, trying to time moving money in and out of the market, and the risks this presents to long-term portfolio returns.
During periods of market volatility, when the interest rates on cash are looking enticing and are competing with short-term investment market returns, it’s common to feel uneasy and contemplate transferring your funds out of the market and into these alternatives. The notion of having instant access to your money and the false sense of security it provides may be enticing. However, it’s important to recognise that this strategy carries substantial risks that can negatively impact long-term portfolio returns and investor outcomes.
Numerous years of extensive academic research conducted worldwide consistently demonstrates that doing this, even for a short period, then attempting to time re-entry into investment markets is extremely challenging, if not impossible, and poses a risk to long-term returns.
The saying “jam today, bread tomorrow” illustrates the concept of opportunity cost when it comes to leaving the market in favour of short-term gains from high-interest rates on cash. You may enjoy the immediate benefits (the jam), but you’ll later struggle to determine the right time to re-enter the market, missing out on its recovery and the superior performance of your portfolio (the bread).
Goldman Sachs, a leading global investment bank, conducted an analysis that demonstrates the significant advantage of investing in the market and holding onto investments for the long term. This holds true even when there are short-term opportunities like higher interest rates on cash or government bonds. Remarkably, this remains the case even for the unluckiest investor who consistently added money to their portfolio at the market’s peak each year, as shown below.
Source: Goldman Sachs, Clever Adviser Technology Ltd, Bloomberg as of May 21st, 2023
The chart above shows three portfolios, invested from 2000 to 2023, all starting with $100,000. Portfolio 1 (far left) is invested in the US market, and every year an additional $12,000 is added to the portfolio at the market low of that year, when the only way is up thereafter. Portfolio 2 (middle) invests in that same US market, adding an additional $12,000 a year at the high of the year, when the only way is down thereafter. Portfolio 3 (right) invests in short-dated US government bonds, which drive cash deposit rates and currently look very attractive. However, the chart shows that, even the unluckiest investor [Portfolio 2] who remained invested in the market over the last 23 years, still outperformed the investor who opted for the seemingly safer option.
To illustrate the dangers of exiting the stock market during periods of high-interest rates, the following chart displays the returns of both stocks and bonds (cash equivalents) over one, two, and three-year periods following the height of the interest rate cycle. Historical data indicates that markets often outperform after interest rates peak, as these periods coincide with market lows. After hitting these lows, markets tend to experience significant rebounds and outperform the alternative investment options that investors have just entered.
Source: Clever Adviser Technology Ltd, FE Fund Info as of 29th June 2023
So, where does this leave us today with the health of the global economy and prospects for recovery as we look ahead? We cannot predict the future, but we can learn from the behaviour of markets historically.
Key takeaways from the past:
- Throughout history, markets have consistently bounced back from periods of negative news and low sentiment, even though it may seem impossible to foresee during those times.
- Holding onto your investments and patiently waiting for the recovery has proven to be the most effective approach for achieving strong long-term returns on your portfolio.
- By maintaining a well-diversified portfolio that includes various regions and asset classes, you can ensure that your investments are strategically positioned to benefit from the eventual global economic recovery.