Total time: 9:02
Jessica: Welcome back to the Sage Advice podcast. I'm Jessica McHugh, marketing director here at Sage Advisory, and today I have with me Regional Consultant Roman Samuels. So today I'd like to discuss the topic we often get questions about from advisors, should an investor go to cash during turbulent markets?
0:19
Roman: There's a couple of things with regards to cash. So the first is we need to think about, what are the concerns? And what are the risks of going to cash throughout different market environments. The first risk and concern that I see with a go to cash strategy is inflation. Now, what is inflation? Inflation is the idea that every year prices go up, the prices of goods and services in the economy, they go up. So if you buy a car this year for $30,000, that same car next year, most likely will increase in price. And roughly right now, we have an inflation rate sitting right around 2%. Roughly speaking, what that means is the prices of goods and services in our economy are going up roughly by 2% every year. So what does that mean for investor’s cash? That means that if you had $100,000 just sitting under a mattress, not being invested in anything whatsoever, that means that your ability to purchase things is going down by 2% every year. If the inflation rate is around 2% -- we call this your purchasing power, your ability to purchase goods and services is eroded by inflation. Now, right now, inflation sitting at around 2%. That tends to be, you know, that's a rate that the Fed has kind of targeted.
1:50
Jessica: Great. So inflation is the first main concern. And then what's another concern?
Roman: Yeah, so inflation is the first main concern in the in the sense of, if you're not invested in the market, your assets are not earning a rate of return. But the second, one of the second concerns that we have to be aware of, is the idea that going to cash can actually impair a portfolio, right? A portfolio’s return. What do I mean by that? If I have a strategy where my primary form of risk mitigation is to sell the securities I own in the market and move those assets into cash, I'm essentially engaging in market timing. In other words, I'm not moving out of one security and into another security, I’m moving out of a security and into cash entirely. So I'm taking my money out of the market entirely. That is market timing. Now, market timing is a very difficult thing to do over the long term. You may be able to get it right here and there. But what that means is, that means that you have to be always correct in your forecasting, always correct in your purchase price, and in your sell price. And what we find is that when you are engaging in market timing, over and over and over again, over the long term, it usually means in practice that you end up doing this -- when the market starts going down, you sell. And when you put your assets into cash, and you wait until the markets start recovering and start coming up again, and then you buy back in. So essentially, in practice, what this can often look like is you sell it the lows and you buy towards the highs. And so you're kind of clipping your return on kind of both ends of the trade. So going to cash is your primary form of risk mitigation. I'm not saying it can't work, I'm simply saying that it is engaging in market timing. And that that is a very, very difficult investment discipline to do over a long period of time.
3:55
Jessica: What do we tell advisors to advise their clients to do?
Roman: Yeah, we don't think that cash is the best form of risk mitigation. What is a good form of risk mitigation? So let me clarify here, we don't think that going to cash is necessarily the worst idea in the world across our strategies. But we would prefer to do a couple things differently. And we would prefer to focus on market segments and rotating into and out of market segments. Let me give you a couple examples here. Over the last 15 years, we look at the various market segments within both fixed income, and within equity, people will say, well, what was the worst year? People, without a doubt, they'll say, 2008. 2008 was the worst year. And there seems to be this idea among investors that everybody lost money in 2008, it's not true. In 2008, there were a variety of market segments within fixed income that actually posted positive returns. One of them was U.S. Treasuries. In fact, our Sage core plus portfolio was long Treasuries in 2008. So that's just one example there in fixed income, where even in the worst time period since the Great Depression, there was still an advantageous market segment to be in. It's simply a matter of finding it. So what we would say is, instead of going to cash and getting out of the market entirely, why not try and rotate into a market segment that would be more advantageous to be in?
5:21
Jessica: Okay, but what about investors who still feel safer when they have a cash allocation?
Roman: Yeah, great question. So you could, you know, allocate to a managed account that has a cash component to it, which either it will move to cash during certain types of market environments, or certain types of criteria, or maybe it holds a permanent cash allocation to it. And our thought behind this is number one, you're going to experience, like I talked about earlier, that cash drag. You're going to have some type of portfolio return that is going to be impeded by a permanent cash position. But there's another thing to think about. If you're an advisor and you've allocated your client’s capital to a managed account, or some type of investment portfolio that has a permanent cash allocation or a substantial cash allocation -- over time, it's going to become harder and harder for you to justify a 1% management fee. Or if you if you put all of the players involved, the investment manager, the platform fee, the advisory fee on top of that, and then the client’s going to at some point in time, think, wait a minute, why am I paying almost 1.5% in fees to hold cash? And that that's a very good question. And we think to advisors, do you really want to be in a situation where you're being asked that question?
6:49
So to us, here's what we would say: for whatever component the client wants to have as a cash allocation, absolutely take that cash and put it in a in a bank savings account or money market account, something that's going to earn them, say, 1% or 2% in interest. Rather than putting it into a managed account or an investment portfolio that has the ability to maneuver that cash allocation, we think it's a cleaner allocation to put your cash into a cash account, like a savings account, or a money market account and let it earn some interest and don't charge advisory fees on that. And the amount that the client is comfortable putting into the market, put it into a strategy that is going to be as fully invested as possible to try and capture as much of the market return as possible to, again, preserve the purchasing power and outpace inflation to try and cycle into market segments that are advantageous when markets are looking volatile. And to make sure that the overall portfolio is not is not dragging too much in terms of return because of this outsized cash allocation.
7:59
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Intro Music brought to you by Kevin MacLeod “Feeling Good” licensed under Creative Commons By Attribution 3.0 license. Creative Commons.org
