Cash is a terrible long-term investment, even at 5% interest

Summary

In this insightful video, Ben Felix delves into the widely held belief that cash, even with a 5% yield, is a secure long-term investment. He challenges this notion by asserting that cash, while stable in nominal value, actually poses significant risks for long-term investors who may lose purchasing power over time. Felix emphasizes that stocks and bonds, though seemingly volatile, have historically offered higher real returns and serve as better hedges against falling expected returns. He explains that long-term inflation index bonds are a safer bet for those thinking ahead, contrasting the allure of cash's current yield with its unpredictable long-term performance. Felix concludes that, despite current high interest rates, cash will likely underperform compared to stocks and bonds, thus endangering long-term financial goals.

Highlights

• Cash isn't the risk-free asset it's perceived to be for long-term growth. ⚠️
• Inflation index bonds offset falling expected returns, a vital factor for investors. 💼
• Interest rates might make cash attractive now, but it's a risky bet for future planning. 🎯
• Stocks and bonds offer risk premiums that cash cannot match, even at high rates. 🔝
• Historically, holding cash poses a higher chance of losing purchasing power. 📉
• Jumping into stocks after a market dip beats holding onto cash waiting for a perfect entry. 🚀

Key Takeaways

• Cash may seem stable with a 5% yield, but it's risky for long-term investors due to potential loss in purchasing power. 💡
• Stocks and bonds, while volatile, historically provide higher real returns, making them better long-term investments. 📈
• Long-term investors should consider inflation index bonds for stability despite market fluctuations. 🔍
• High interest rates on cash are enticing but misleading for long-term growth. 📊
• Despite cash's immediate appeal, its unpredictable returns make it a poor long-term investment choice. 🚫

Overview

Ben Felix, a portfolio manager at PWL Capital, dives into the common misconception that cash, especially with a 5% yield, is a safe long-term investment. He argues that while cash feels safe because of its stable nominal value, it's actually quite risky for long-term investors. Cash often loses purchasing power over time, unlike stocks and bonds which offer higher real returns and better safeguard against diminishing expected returns.

Felix explains that while cash is appealing in terms of daily stability, it lacks the security long-term investors need to protect against falling expected returns. Long-term investments like inflation index bonds provide a more secure alternative as they account for future volatility in expected returns. He highlights the pitfalls of relying on cash or short-term bonds which might not sustain long-term financial goals if interest rates drop.

Ultimately, Felix concludes that cash, despite its current high-interest appeal, underperforms compared to stocks and bonds in the long run. High interest rates are tempting, but they shouldn’t distract long-term investors from choosing assets that promise better growth and protection against future uncertainties. Stocks, bonds, and inflation index funds are shown to consistently outperform cash, painting a clearer picture for savvy long-term investors.

Chapters

• 00:00 - 00:30: Introduction and Overview The chapter discusses the reasons why cash, despite having a stable nominal value and a seemingly good yield of 5%, is not a favorable investment for long-term investors. It highlights that cash is risky over the long-term as it fails to effectively hedge against falling expected returns and is more likely to lose purchasing power compared to stocks and bonds. Furthermore, with historically higher real returns on stocks and bonds, especially at higher real interest rates, cash is a comparatively poor long-term investment option.
• 00:30 - 01:00: Cash vs. Long-term Investments In this chapter, Ben Felix, a portfolio manager at PWL Capital, elaborates on why cash is a poor choice for long-term investments, even in times of high interest rates. He clarifies that his discussion pertains to funds intended for long-term investment rather than cash held in emergency funds, which should remain accessible and low-risk. He also notes that high-interest savings accounts and related ETFs presently offer attractive returns for retail investors.
• 01:00 - 01:30: Interest Rates and Investment Behavior This chapter explores the relationship between interest rates and investment behavior. At present, offering over 5% annual interest suggests a competitive yield compared to long-term investments like stocks and bonds. The text discusses how investors' exposure to risky assets is influenced by interest rate levels. Lower interest rates lead to a higher appetite for riskier assets, whereas higher rates promote safer investments like cash. The chapter underscores cash's safety amidst market volatility, particularly in stable countries like Canada, while stocks and bonds frequently fluctuate in value.
• 01:30 - 02:00: Cash as a Risk-Free Asset The chapter discusses the common perception among investors that market crashes are imminent, leading them to be more cautious than necessary and reducing their investment in risky assets like stocks. It explains the dual nature of risk in investing, emphasizing that while risk sounds dangerous, it is not inherently negative. The chapter also challenges the widely held belief that cash or short-term government bills are risk-free assets. It clarifies that this assumption only holds true for short-term investors, highlighting that while cash's value is stable, its expected return is not predictable.
• 02:00 - 02:30: Long-term Returns and Cash Risks The chapter discusses the allure of a current high yield on cash, highlighting a 5% yield as attractive. However, it warns against overestimating the long-term returns based on this yield, as historical data show a noisy relationship between short-term yields and long-term returns. PWL Capital's projections caution that today's high yield does not guarantee similar future yields, presenting challenges for long-term investors who must consider short-term volatility.
• 02:30 - 03:30: Bonds, Stocks, and Expected Returns This chapter discusses the different perspectives of short-term and long-term investors regarding changes in their financial accounts. Short-term investors are more concerned with immediate losses, such as a sudden 20% decrease in their bank account balance as this affects their immediate spending, like buying lunch. Conversely, if their cash earns a slightly lesser interest rate, such as 3% instead of 5%, it does not disrupt their short-term spending significantly. Long-term investors, however, are more focused on how fluctuations in their portfolio values affect expected returns over time. A decline in portfolio value that is balanced by an increased expected return is not a major concern for long-term investors, highlighting their different risk tolerance when compared to short-term investors.
• 03:30 - 04:30: Purchasing Power and Long-term Goals The chapter discusses the concept of purchasing power in relation to long-term investment goals. It states that for long-term investors, the risk-free asset isn't cash but rather a long-term inflation-indexed bond. The text explains that when an investor secures future coupon payments that are indexed to inflation, they need not worry about interim price drops, as these are balanced by an increase in expected returns. The investor can rely on the coupon payments for regular expenses, like buying lunch, even if the bond's price decreases significantly. The chapter also mentions the volatility of long-term inflation-indexed bond prices, citing recent observations as evidence.
• 04:30 - 05:30: Risks of Holding Cash The chapter discusses the risk associated with holding cash, particularly for long-term investors. While cash remains stable in nominal value and is appealing to short-term investors, it does not respond to changes in interest rates, leaving long-term investors vulnerable to falling expected returns. These returns are crucial for long-term investors who rely on their assets to generate income over extended periods. This stability may not benefit those looking for growth and returns into the future.
• 05:30 - 06:00: Conclusion The chapter emphasizes the strategic advantage of long-term bonds over short-term bonds for securing financial stability and ensuring a sustainable lifestyle in the future. It points out that while a 30-year bond maintains its value even if interest rates drop, a series of short-term bonds can leave an investor vulnerable to interest rate fluctuations that result in funding shortfalls. Additionally, the chapter draws a parallel between stocks and bonds by suggesting that when stock prices decrease, their expected returns increase, similar to the behavior of bonds. This implies that long-term investments, whether in bonds or stocks, have inherent qualities that can protect and enhance future financial security.

Cash is a terrible long-term investment, even at 5% interest Transcription

• 00:00 - 00:30 with a 5% yield on cash why would anyone want to invest in stocks and bonds I know that cash feels good because it's nominal value is stable it feels safe but it's counterintuitively extremely risky for long-term investors cash is a poor hedge against falling expected returns it is historically much more likely to lose purchasing power than stocks and bonds in the long run and real Returns on stocks and bonds have historically been higher at higher levels of real interest rates making cash a relatively poor long-term invest
• 00:30 - 01:00 M even when interest rates are high I'm Ben Felix portfolio manager at pwl Capital and I'm going to tell you why cash is a terrible long-term investment I want to be clear to start that this video is about money that you can direct toward long-term Investments keeping cash set aside in an emergency fund is often a good idea and that cash should not be kept in anything volatile since it's set aside to cover short-term needs highin savings accounts currently available to retail investors through highin savings account ETFs are paying
• 01:00 - 01:30 more than 5% in annual interest at this moment when you can get a 5% yield on your cash stocks and bonds might seem to lose some of their luster as long-term Investments It is Well documented that investors exposure to risky assets is sensitive to interest rates when interest rates are lower investors reach for yield in riskier assets and when interest rates are higher they reduce their exposure cash is safe dayto day when markets are volatile cash especially in a country like Canada is going to be there when you need it while stocks and bonds change in value often
• 01:30 - 02:00 materially every day investors are always worried about the next market crash probably more worried than they should be and this results in reduced exposure to risky assets like stocks risky assets sound risky and they are but risk is not always a bad thing in investing most investors think about cash or short-term government bills as the risk-free asset in managing their portfolios but this is only applicable to a short-term investor the first thing to understand about cash returns is that while the value of cash is stable the expected return on cash is unpredictable
• 02:00 - 02:30 the current 5% yield on cash is definitely attractive but the relationship between the current short-term return on cash and the long-term return on cash is at best very noisy based on regression analysis of historical data we attribute only a small portion of the expected return on cash to its current yield when we run financial planning projections at pwl Capital a 5% cash yield today does not mean a 5% cash yield tomorrow and this is a problem for long-term investors short-term volatility matters a lot to
• 02:30 - 03:00 short-term investors if you wake up tomorrow and you have 20% less money in the bank account that you're going to use to buy lunch you will not be happy on the other hand if you wake up and your cash is earning 3% interest instead of 5% you can still afford your lunch long-term investors care less about volatility and more about how their expected returns change with volatility for example a drop in the value of a long-term portfolio that is offset by an increase in the portfolio's expected return is actually irrelevant to a
• 03:00 - 03:30 long-term investor based on this the risk-free asset for a long-term investor is not cash it's a long-term inflation index bond in simple terms when you lock in your inflation index future coupon payments from your bond you don't really care about the price of your bond in the interm since a drop in prices is offset by an increase in expected return you can use the coupon payments to buy your lunch even if the bond price Falls by 20% now what's interesting is that long-term inflation index bond prices can be extremely volatile as we saw in
• 03:30 - 04:00 2022 so a short-term investor would probably call them risky cash does not change in price in response to changes in interest rates its nominal value is very stable day to-day this is great for a short-term investor since they want to be able to spend their cash today and tomorrow but it leaves long-term investors exposed to the risk of falling expected returns expected returns matter a lot for long-term investors since they're relying on their assets to generate returns far into the future if you need $50,000 per year for the next
• 04:00 - 04:30 30 Years and you buy a 30-year Bond you're set even if interest rates fall but if you buy a one-year Bond at 5% and then interest rates fall to say 3% you have a massive shortfall to fund for the next 29 years if expected returns fall long-term bonds hedge your ability to afford your lifestyle in the future while cash offers no such protection in this way stocks are sort of like bonds when their prices fall their expected returns rise this also means that like
• 04:30 - 05:00 bonds stocks are less risky for a long-term investor than their short-term price fluctuations would otherwise suggest when expected returns fall long-term asset prices like those of stocks and long-term bonds will tend to rise offsetting the effects of lower expected returns for long-term investors cash also has lower expected returns than stocks and bonds in most environments since cash does not command a risk premium stocks and bonds are expected to earn a premium above and beyond the return on cash to compensate investors for taking risk based on this
• 05:00 - 05:30 we should expect that when interest rates increase expected Returns on stocks and bonds also increase and this is exactly what we see in the data in a global sample of countries with continuous histories back to 1900 5-year Returns on stocks and bonds sorted on their starting real interest rates increase with higher starting interest rates this suggests that as Theory would predict the risk premiums for stocks and bonds above cash are persistent even at higher interest rates this is important
• 05:30 - 06:00 even if interest rates are high expected returns are being left on the table when you hold cash this consistently lower expected return on cash means it will be much more challenging to meet your long-term financial goals you'll need to expect to save more or spend less in the future to compensate but the lower expected returns also increase the risk of losing purchasing power in the long run investors have historically been significantly more likely to lose purchasing power holding cash measured by short-term government bills than
• 06:00 - 06:30 holding stocks or Bonds in the long run in a broad sample of 38 developed markets from 1890 to 2019 the bootstrap estimate of 30-year real loss probabilities for government bills is 37% compared to 27% for intermediate bonds 133% for domestic stocks and 4% for international stocks not only has the probability of loss been greater but the magnitude has as well importantly this is only true at longer Horizons at Short Horizons as you would hope cash has been safer than stocks and bonds if
• 06:30 - 07:00 you hear this and think that you'll hang tight sitting on cash until the market drops and then invest in stocks I have a word of caution when we've looked at the idea of buying the dip sitting on cash until a market drop of 10 or 20% and then investing in stocks we found that buying the dip Trails investing a lump sum most of the time and by a wide margin on average this finding is consistent with stocks and bonds having higher expected returns than Cash Cash yields are currently High potentially
• 07:00 - 07:30 enticing long-term investors to hold cash rather than investing in stocks and bonds the problem is that the expected return on cash is unpredictable and cash does not offer a hedge against falling expected returns which can be materially detrimental to long-term investors cash also has lower expected returns than stocks and bonds in all interest rate environments and is much more likely to lose purchasing power in the long run holding cash can feel really good and even better at 5% but long longterm investors are likely better off in
• 07:30 - 08:00 stocks and bonds in the long run thanks for watching I'm Ben Felix portfolio manager at pwl Capital if you enjoyed this video please share it with someone who has their long-term Investments sitting in cash [Music]