Consistent Compounding #001: Cash is

Still Trash
By Ankur Shah

Ray Dalio, the founder of Bridgwater Associates, popularized the phrase "cash is trash"
when interest rates were significantly lower. He correctly observed that net of inflation
and taxes, cash has historically produced a negative return. Thus, rational long-term
investors should never hold significant amounts of cash in their portfolios.
 
However, assets in money-market funds have ballooned to an all-time high. Money
market funds are a type of mutual fund that invest in high-quality, short-term debt
securities and pay a dividend that reflects short-term interest rates. Many investors use
these funds as a short-term place to park cash. Currently, money market funds are
offering 4%-plus interest rates. Thus, it's reasonable to assume that cash is no longer
trash and offering an attractive yield for the first time in decades.
 
Superficially, it appears that investors are simply piling into money market assets as a
logical response to higher interest rates. If you take a longer view, you'll realize that
retail investors typically move into money market assets during times of high volatility
and economic uncertainty. They aren't being attracted by the potential for higher
returns, rather they're fleeing other asset classes where they fear returns will be
negative. From the chart below, we can see that retail investors have parked $1.35
trillion in money market funds an all-time high.
You'll also notice that prior peaks have all coincided with recessions, the grey-shaded
areas in the chart above. The problem is that equity markets will always bottom
anywhere from 3 to 6 months ahead of the economy. Retail investors tend to flee to
cash, more or less simultaneously and at precisely the wrong time.
 
In fact, every time an all-time high has been reached it was the beginning of a new bull
market. You can see in the chart above that the first great peak was in 1982 and was the
beginning of the greatest bull market in history that largely ran uninterrupted till the
dot-com bubble burst in 2000. Similarly, the next great peak occurred during the
double market bottom in October 2002 and March 2003, which led us into the housing
bubble. Moving forward we see another all-time high in late 2008 and 2009. I'm sure
that most of you will remember that the market bottomed in March 2009 and became
the longest bull market in history.
 
This brings us to the current all-time high. It's more than likely investors are fleeing
from bank failures and the most widely forecasted recession in history. However, it's
important to remember that cash is not trash because of its poor returns. In the current
scenario, cash is producing an adequate return but retail investors may prove once
again that it's the wrong time to be hiding in it on the sidelines.