Hitting the Pause Button

Originally published on April 24, 2022.

2022 was supposed to be the year that we could start recovering from the pandemic and finally move on with life. Instead, we’re dealing with war, inflation, and the most volatile markets we’ve seen in years. The sudden change in market conditions, driving down both bond and stock prices, caught even the most savvy pros flatfooted. 

In this kind of environment, sometimes it helps to take a step back and hit the pause button. Find a way to make things simpler, not more complicated. Filter out the noise and complexity and consider your investment needs in their simplest terms.

One simple planning approach is to break things down into two straightforward categories: 

• Money I know I’ll need in the next 2 years; and 

• Money I know I can set aside for 10+ years.

Let’s explore each.

Live to Fight Another Day: Cash and Cash-Like Options for 2022-2023

If you think about the next two years, how much cash do you need for expenses and purchases? How much do you want in your emergency fund? How much for a “safety blanket?” This is the amount to set aside in cash or cash-like investments.

Cash is the ultimate stable asset. If held in an FDIC-insured account, there is no chance of losing money. No matter what the stock market does, your cash will be constant. For people who need or want to hold a lot of cash, the good news is that rates on FDIC-insured accounts like high-yield savings and CDs are finally going up.

Online banks like Ally and Marcus already pay 0.50% APY on high-yield savings accounts, and those rates should automatically adjust upward as the Fed raises rates. As of April 22, 2022, a 9-month non-callable CD issued by Goldman Sachs is at 1.1%, and a 2-year non-callable CD issued by Goldman Sachs is at 2.6%. These rates might continue to tick up, but they are high enough that we’ve started buying them for certain clients.

I Bonds at TreasuryDirect.gov continue to be compelling. They currently pay an annualized rate of about 7%, and the rate will adjust every six months based on inflation. You’re capped at $10,000 per person per year, and the bonds can’t be liquidated for the first 12 months, but nevertheless they are a great option for most people. (For more details, see our December 2021 post.)

Finally, a creative option for homeowners with a lot of equity is to put in place a home equity line of credit (HELOC), but not necessarily use it. Having access to equity without needing to sell your home can give peace of mind for all the “what ifs” that creep into our minds during turbulent times.

The calculations to determine your desired cash reserves should be pretty straightforward. Once you have a plan for the amount you want to keep safe today, then it’s time to think about your future self.

Stocks for 2032 and Beyond

With stocks experiencing massive volatility, is it time to get more conservative? I’m inclined to say that for investments that can be held for 10+ years or longer, the answer is “no.”

If inflation runs at 4-5% and safe assets only return 2-3%, you are locking in an inflation-adjusted loss. That may be okay for the next few years, depending on your risk tolerance and employment status. But over longer periods of time, your goal should be to exceed inflation to maintain your standard of living over your lifetime.

Inflation – and the interest rate increases expected to battle inflation – is taking a toll on the stock market. Over the past year, the S&P 500 is up barely +3%, and the tech-heavy Nasdaq is down over -4.6%. This is consistent with previous periods of high-inflation. And if high inflation persists (5%-plus annualized), we can expect the struggle to continue. In those environments, stocks have barely outperformed the rate of inflation.

Source: CFA Institute, July 2021

But there could be an upside. For instance, look at the green bar, which shows inflation regimes that average between 0-5% annually. If inflation today is north of 8%, but is widely expected to come down to 4-5% by the end of the year, we could quickly end up back in an environment where the outlook for stocks is much, much better. If your long-term money is in stocks, you’ll be on that train when it leaves the station.

While these are challenging times for markets, we’ve experienced challenges in the past. Markets have weathered higher inflation. They have weathered world wars and recessions. And yet, the stock market has delivered relatively high returns over the long run. If the future is similar to the past, stocks could double every 7-10 years, give or take a year. If cash averages about 2% per year, it would take 35 years to double.

If you have more than 10 years to wait – and have sufficient cash to wait – which would you rather have?

Next Steps: Adjusting Plans and Carving Out Cash

Something I’ve been telling folks is that it’s possible to be both a short-term pessimist and a long-term optimist. By bifurcating your portfolio in such a way to provide short-term stability in cash and long-term growth in stocks, you can have confidence that your short-term self and your long-term self are both well cared for.

This market continues to be a challenge, and there is no real clarity in the short term. If you do choose to seek refuge in safer assets, talk through the implications to your long-term plan with your financial advisor.