THE first month of a new calendar year is often a time when many of us plan our investments for the coming year. One topic that always enters the conversation these days is what to do with cash deposits. In our Outlook 2024 report, we laid out a clear preference for equities and bonds over cash.
However, with cash yields still in the region of 5 per cent, is the potential additional return worth the risk? We strongly believe it is, and particularly so today given our outlook for interest rates.
Cash threshold less difficult to beat today
We believe a cash return threshold of around 5 per cent is less difficult to beat today. Most bond yields or income-generating assets already offer yields that are higher than what is available on cash. Over longer time horizons, this yield forms a rising share of total returns, making this factor increasingly compelling as the horizon extends.
High-quality investment-grade government and corporate bonds do still offer a slightly lower yield than cash. However, falling bond yields means higher bond prices. We expect bond yields to continue trending lower as the US Federal Reserve gets ready to cut rates later in 2024. It would take a relatively small fall in bond yields for total returns to beat cash. Hence, we find bonds particularly attractive as this decline in yields is likely to occur when cash yields themselves start falling.
What about equities? Many investors are still smarting from 2022’s experience, but 2023 proved to be a reminder that equities still outperform bonds and cash in most calendar years.
Today, at the start of 2024, we believe there is room for the late 2023 equity rally to extend. This is not only supported by still-resilient growth, but also by stronger 2024 earnings expectations across most major markets. A sharper slowdown in growth would of course raise risks for equities, but that reversal could very well occur from a much higher starting point.
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Think like a chess player: reinvestment risk
One of the key risks of holding too much cash is reinvestment risk – that is, the possibility that yields on cash and other major asset classes turn significantly lower when current investments mature. We believe this risk is becoming more real by the day.
To illustrate this with a simplified example, we compared two potential paths for five-year investments. The first option assumes cash yields that remain in the 4 to 5 per cent range for the first two years, but fall sharply to 2.5 per cent thereafter. This scenario would largely fits our own rate view over the next 12 months and the Fed rate experience in past economic cycles.
The second option assumes buying a five-year bond that offered a 4 per cent yield till maturity. The second option ends up offering a higher total return, even though the first offers a higher yield today. This is because the first option forces the investor to accept falling yields over coming years, while the second option allows the investor to lock in today’s attractive yields for five years.
Thinking a few steps ahead, like a chess player, is key to using today’s market to lock in attractive yields for as long as possible.
Protect against inflation over the long run
Every year, we update our long-term (seven to 10 years) market return assumptions. While these are not forecasts, they offer a broad view of how asset class returns are likely to rank over a long period. These assumptions are based on what we can learn from history, drivers of major asset classes and today’s starting point.
These assumptions make an even more compelling argument for investors to move out of cash today into a diversified portfolio. Cash yields may be higher than what we have been used to over the last business cycle since 2008, given the unusual zero-interest rate environment at that time.
However, over a longer historical timeframe, cash still ranks as an asset class which is likely to offer one of the lowest returns relative to other asset classes. Therefore, getting and staying invested beyond cash remains a key step in generating returns and dealing with inflation.
2024 outlook: Get and stay invested
In our Outlook 2024 report, we favour an overweight position in global equities and bonds, which comes at the expense of an underweight in cash. We also hold benchmark allocations in gold and alternative strategies.
There is almost always a lot to worry about in financial markets. But we believe getting and staying invested in a diversified portfolio, instead of staying in the perceived safety of cash, is likely to best serve investor goals over the long run.
The writer is chief investment officer for Africa, Middle East and Europe at Standard Chartered Bank’s wealth management unit
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