One of the common thoughts when investing is not to invest in the stock market if you need the funds in the short-term. While stocks may offer great upside, they also offer considerable downside and an average probability of a positive return.
Historically in 12 month rolling periods since 1871, Stocks (here represented by the S&P 500 Total Return Index) have returned an average of about 11% with the best performance being 165%, the worst performance being -67%, and positive return periods of roughly 70% of the time (Source: Capital Advisors, Ltd.). Not a great savings vehicle for when you need a fixed amount of funds in the next few years.
Conversely, what is not often discussed are the long-term dangers of cash. While near-term Cash returns offer stability in exchange for a marginal rate of return, over the long-run inflation can eat away at those returns and actually leave you with less buying power than you started with.
Historically in 30 year rolling monthly periods since 1926, Cash Equivalents (here represented by the 30 Day T-Bill REAL Returns) have returned an average of about 0.4% annualized the best performance being 2%, the worst performance being -2%, and positive return periods only 65% of the time (Source: Capital Advisors, Ltd.). So probably not a great savings vehicle for when you don’t need funds until years from now.
However, it’s the opportunity cost versus stocks that is the greater risk. The chart below compares the real 30-year forward annualized return on Stocks less the return on Cash.
(Source: Capital Advisors, Ltd.).
Thus, the worst stocks have ever done versus bonds is about 3% annualized on real basis. Let’s use an example with real numbers and model that out using the following assumptions:
- You invest $1,000,000 dollars
- Real annualized Stocks returns are low over the next 30 years, say 4% (average 30 year real rolling period is 6.6%) (Source: Capital Advisors, Ltd)
- Real Cash returns are 1%, which would match the best performance Cash has had historically versus Stocks (Source: Capital Advisors, Ltd)
- We assume 4% real annualized Stck returns; thus is we take the best 30 year performance period for Cash when compared to Stocks (underperformance of 3% annualized) we arrive at 1% real annualized returns for Cash.
- If you invested in the Stock market, you would have roughly $3.2m. If you left the funds in Cash, you would have roughly $1.3M. In other words, you would have had roughly $1.9m more than if you invested in Cash in real terms after 30 years!
As the numbers bear out, Cash may be appropriate when you need funds in a short, fixed amount of time; however, Cash for the long-run may be a higher risk for lower returns when factoring in the loss of purchasing power.
S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market.
30 Day Treasury Bill (T-Bill) is a short-term debt obligation backed by the Treasury Dept. of the U.S. government with a maturity of 30 days.
Real Return is the annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other external effects.
Past performance is no guarantee of future results. The above hypothetical example is for illustrative purposes only and does not attempt to predict actual results of any particular investment.
The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment.