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Cash is king, or cash is trash?

Cash is king, or cash is trash?

One sign of a bear market bottom is said to be that cash is king.

  • The idea is that if everyone is so terrified of putting money into risky assets that they’d prefer to hold cash, then all the sellers of equities have already been scared away.

Such times may be a good opportunity to buy shares for the long-term.

In contrast, in bull markets cash is trash.

  • These are the times when you can get 7-10% from savings accounts, which is an excellent return comparable to the long-term return from stocks, and with none of the risk. Yet the stock market keeps rising!

At such times, the authorities have usually raised interest rates to try to dampen the boom. Yet everyone is greedy, sending stocks into bubble territory. You’ll even hear the phrase ‘cash is trash’ being used in newspapers and on TV.

If you hear people saying that, it may be a good time to strategically rebalance your portfolio in favour of bonds or cash.

Using cash as a guide to asset allocation

People are often tempted into trying to time markets, especially when the memory of a bear market is fresh.

Such timing is a difficult in reality, and you’ll often be better investing monthly through the highs and the lows for average returns, or rebalancing according to pre-set asset allocations.

Rebalancing allocations can trigger capital gains tax and cost you in fees, as well as lost returns if your timing is wrong.

But if you are going to try to strategically manage your equity exposure, then watching how investors treat cash at any point in time might be a useful tactic (alongside monitoring dividend yields and the average market P/E ).

For instance as I write in early 2010, you can get 4% from the best cash ISA savings accounts, which is far ahead of the base rate of 0.5%.

However, I wouldn’t say cash is trash just yet, because institutions can’t get anything like 4% from the short-term bonds they invest in as a near-cash equivalent. They currently get less than 1%.

They can get over 4% fixed from 10-year UK government bonds – a huge spread over short-term rates, but still not very attractive compared to 3.25% from the FTSE 100, given that dividend income should rise over time.

I therefore think it’s currently sensible to prefer shares to cash or bonds. For now, the yield situation looks good for equities.

Also, financial insiders are still reporting there is a lot of cash on the sidelines after people stopped investing in equities and other risky assets during the bear market. So even now, cash is king in a lot of investors’ minds.

Usually there’s very little cash around at the top of a market. In fact, people often start borrowing to invest – a classic sign of a toppy market! Again, cash is trash doesn’t hold right now on that score.

Lots of money was put into stocks in the latter half of 2009 and more will come in 2010. But I don’t think cash is trash quite yet.

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{ 19 comments… add one }
  • 1 Rob Bennett March 8, 2010, 2:56 pm

    Such timing is a difficult in reality, and you’ll often be better investing monthly through the highs and the lows for average returns, or rebalancing according to pre-set asset allocations.

    I’ve heard many people say this. But when I checked the historical data myself, I learned that there is zero truth to it. Stocks have always provided a great long-term return when purchased at moderate or low prices. Stocks have always provided a poor or negative long-term return when purchased at insanely dangerous prices (like those that applied for the entire time-period from 1996 through 2008). There’s not one exception in the historical record, which dates back to 1870.

    It seems to me that the simple rule is to invest in stocks when they are priced reasonably or better and to avoid them when they are priced insanely high. What’s the difficulty?

    The confusion stems from a failure to distinguish short-term timing. It is certainly true that it is difficult (if not outright impossible) to make allocation changes that are guaranteed to pay off in a year or two. Only long-term timing (allocation changes made with an understanding that they may not pay off for five years or even ten years) works.

    Rob
    .-= Rob Bennett on: Treasury Inflation Protected Securities Are Today’s Most Underrated Asset Class =-.

  • 2 The Investor March 8, 2010, 5:59 pm

    @Rob – Nobody is arguing that if you buy shares when they’re cheap they’ll go up in value. No revelations there! The trouble is valuation is not a clear cut science, due to the interaction of both price and earnings. Back in March 2009, virtually all the valuation crowd were saying the market hadn’t fallen far enough. Since then it’s got up 70%.

    Also, the market is rarely very cheap or very expensive – it’s usually something in between.

    As I’ve said before, I take valuation into account when I invest, but I don’t pretend it’s not risky. Asking the average person to sit out the market for years on end is not likely to produce a good overall investing outcome for many of them, because they will fail to get back in at the right time. In contrast, saving every month to smooth out their buying prices and reinvesting dividend income is a credible strategy that is likely to deliver good returns over the long term.

    Anyway, we’ve both said our bit now so let’s hear what others have to say.

  • 3 Financial Samurai March 8, 2010, 11:27 pm

    I’m happy to just have my cash hoard earning 4.1% on average here in the US. Just think, $4 million in cash at 4% yield is $160,000/yr. That’s good enough to live on with no rent or mortgage yeah?

    Everything else is play money, an illusion. I separate everything out, and roll with it.
    .-= Financial Samurai on: The Curse Of Making Too Much Money And Not Pursuing Your Dreams =-.

  • 4 FinEngr March 9, 2010, 1:41 am

    Before work this morning I sat here, reading this article, and drinking some British breakfast tea w/ cream & sugar.

    Now I’m doing the same thing and decided its time to comment.

    First, your posts are enjoyable to read and I’m a little surprised there’s not more discussion.

    There’s two ways I look at it. The more conspirator idea would be that the gurus are purposely trying to steer you away from equities for their own gain (plausible but not probable).

    The second way would be the difference between a sailboat and a freight liner. There’s a certain nimbleness to individual investors that larger funds can’t mimic when moving between investments. Of course, I’m neglecting the “flash trading” that’s been coming up as of recent.

    Best.
    .-= FinEngr on: Financial Lessons From Engineering =-.

  • 5 Money Funk March 9, 2010, 4:35 am

    Where to put all this money I pretend I have is still beyond me! But thank you for making it easy to understand a bear and bull market. 😀
    .-= Money Funk on: Menu Plan Monday: Weight Loss Happy =-.

  • 6 Niklas Smith March 9, 2010, 10:53 am

    On the subject of valuations (of assets generally), here is a very thoughtful column from Buttonwood of the Economist: http://www.economist.com/business-finance/displaystory.cfm?story_id=15580336

    He argues that demographic factors drive saving behaviour, which then drives up the valuation of whatever the asset du jour beyond reasonable levels.

    I think the particular point you are making in this post is also rather insightful – a bit of Buffet-think! (You know, being greedy when others are fearful and fearful when others are greedy – demand for cash is an excellent barometer for fear in financial markets.)

  • 7 Niklas Smith March 9, 2010, 10:54 am

    Correction: “…the asset du jour IS beyond reasonable levels…”

  • 8 roym March 9, 2010, 11:34 am

    Where is the 4% cash isa please?

  • 9 Investor Junkie March 9, 2010, 1:53 pm

    Good article.

    It all comes down to your central bank and their monetary policy. The statement “don’t fight the FED” applies.

    @Financial Samurai: I assume that’s a CD ladder? Right now new CDs it’s hard to get 3% let alone 4% for a 5 year CD. You can get 7 or 10 year CDs but ah… I’ll pass.
    .-= Investor Junkie on: Ginnie Mae Investing =-.

  • 10 Budgeting in the Fun Stuff March 9, 2010, 9:04 pm

    @roym and Investor Junkie,
    Credit unions seem to be offering 4% rate checking accounts up to limits. For example, First Community Credit Union is offering a 4% rate up to $25,000 if you use their debit card 12 times a month and have either a direct deposit or ACH credit to them each month. My husband and I are looking at that right now…the only reason we didn’t immediately jump over to them is that we hate debit cards, but we’ll probably at least try it out. There are other credit unions doing the same thing (I’ve seen a couple mentioned online…I remember Cross Keys Bank)…just look for reward checking in your areas.

    To the article, thanks for explaining bear and bull markets…I hear the terms and never bothered to actually figure out what they meant. We are young enough to happily invest in stocks and mutual funds for a while…we’ll rebalance as we get older. Our main cash is making 2% at Smarty Pig right now and may soon be making 4% at a credit union…I think we’ll have our bases covered.
    .-= Budgeting in the Fun Stuff on: Determining Our "Allowances" =-.

  • 11 The Investor March 10, 2010, 1:27 am

    @IJ – I love that phrase, and it’s proven true again in the past 18 months, no! 🙂

    Our Central Bank is partly trying to get the exchange rate to do some of its heavy lifting at the moment, by benignly devaluing the currency enough to import a little inflation to stave off deflation/recession, while holding rates low to provoke an upturn. It’s an interesting example of what the dollar can’t do, due to it still being the world’s reserve currency – the dollar is weak, but still plenty of buyers unlike for our pound right now!

    Agree @Sam’s 4% seemed high. But then again so did his $4 million! Given @Sam has previously vowed to remain anonymous and financially discreet, I wonder if it was a hypothetical…

  • 12 The Investor March 10, 2010, 1:30 am

    @FinEngr – Thanks for deciding to comment, and I quite agree the lack of discussion surprises me at times. Perhaps people are simply too exhausted after wading through a Monevator article! 😉 More seriously, a friend told me that on a blog like this where I write long posts, it may be better to comment less to let the readers have their say, so I’m trying to hold off a bit before jumping in.

    Regarding the cash king/trash argument, I honestly think it comes down to psychology and emotion. It’s only 10 years ago we saw the dotcom boom – something everyone has been able to see was absolute madness for… 9.5 years! When you’re in the thick of it, it’s easy to get carried away by whatever the market thinks…

  • 13 The Investor March 10, 2010, 1:37 am

    @Niklas – Thanks for that, think I may have linked to it at the weekend but possibly forgot. There’s no doubt valuation plays a huge role – and this Economist article proves yet again what certain commentators on the Internet say about valuation being ignored is simply not true – but the trouble is overvaluation only looks obvious in retrospect.

    Regarding demographics, I’m part persuaded. It would certainly help explain why Government bonds are now trading at silly lows despite massive issuance and the expectation of more – pension funds buying them up to fund boomer annuities?

  • 14 Faustus March 10, 2010, 2:10 am

    I don’t think you should focus too heavily on the number of comments. I read regularly, and often the comments too, but whether or not I contribute is based on time, and also what has already been said.

    I find that frequently a good and insightful blog post generates less in the way of comment than a bad one, because there is little within that people feel they need to contradict.

    I agree that this isn’t a particularly bad time for investing in equities; it’s just that it doesn’t seem a good time either, with stocks seemingly priced for a strong recovery, leaving little room on the upside.

  • 15 The Investor March 10, 2010, 1:31 pm

    Thanks for your thoughts Faustus – I think I read somewhere that 10% of readers read the comments and 1% actually comment, so your thoughts chime with that.

    As a long-time reader you may remember when I didn’t enable comments. I sometimes think of turning them back off, particularly when I see dangerous comments about volatility being optional or whatever being voiced after a carefully crafted post, but some readers feel blogs are blogs without the ability to comment, so on they stay! 🙂

  • 16 Evolution Of Wealth March 10, 2010, 2:00 pm

    Judging by investors behaviors in the past, the biggest outflows from the S&P 500 are at it’s bottom while the biggest inflows are at the top. The average person fails miserably at rule #1 of investing. The best advice in the post, for the average person, is to continue to invest through ups and downs.
    For people that aren’t average you could probably follow people’s emotions by following the flow of cash. Definitely interesting.
    Then what @Financial Samurai isn’t telling you is that he really doesn’t get $160,000. What tax bracket are you in? Maybe he ends up with $120,000? Then the all might question of compounding versus netting? Is it getting better or worse?
    .-= Evolution Of Wealth on: 7 Disability Insurance Add-on Features =-.

  • 17 Investor Junkie March 10, 2010, 3:05 pm

    @Budgeting in the Fun Stuff: True, but those rates are not fixed… Could be changed at any time and many banks recently have. So while I’m not saying it’s completely a bad idea, be prepared to move to another bank/investment.

    @The Investor: If we didn’t have the reserve currency we more than likely would be in the same boat your county is in… Membership has it’s privileges. 🙂 But for how long?
    .-= Investor Junkie on: Ginnie Mae Investing =-.

  • 18 Tom @ Canadian Finance Blog March 10, 2010, 7:13 pm

    I agree that now would be a great time to be taking any cash and investing for the future. Unfortunately I don’t have any to invest since in the past year I bought a house and had a child! 😉
    .-= Tom @ Canadian Finance Blog on: How I Got $8 Glasses =-.

  • 19 Budgeting in the Fun Stuff March 10, 2010, 7:30 pm

    @Investor Junkie: Very true…I’ll keep a lookout for rate changes, but it’s still better than a CD right now…
    .-= Budgeting in the Fun Stuff on: Determining Our "Allowances" =-.

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