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I Would Have Been Better Off in a CD!

I Would Have Been Better Off in a CD!

February 15, 2024

I Would Have Been Better Off in a CD! 

The past 3 years taken in total have not been very productive for investors.  Despite the strong rally in market indexes in 2023, returns for most investors for the trailing 3 years have been meager.  Much of the poor performance can of course be chalked up to the abysmal performance of markets in 2022 – but nonetheless, investors can be forgiven for noting that they could have done better with cash in a CD or high yield savings account for the past 3 years.  Consider the annualized performance of the following asset allocation strategies over the trailing 3 year period: 

Ishares Core Growth Allocation ETF:  +1.63%

Ishares Moderate Allocation ETF:  -0.2%

Ishares Core Conservative Allocation ETF:  -0.82%

During the same 3 year period, the US stock market is actually up about 7% per year, so much of the poor performance of the asset allocation strategies is a result of exposure to bonds and non-US stocks.  The bond market was of course severely impaired due to the almost unprecedented rapidity of interest rate increases from 2021 through 2022, while foreign stock returns have trailed the US stock market for a variety of technical reasons, including lower exposure to the soaring tech sector and a persistently strong dollar supported by high interest rates.  The Vanguard Total Bond Market ETF was down 3.67% per year, while the Ishares MSCI All Country ex US ETF was down  1.42% per year.

Our client investment portfolios have by and large outperformed their comparable allocation funds (yes, even after my fees!).   This is due in part to the strong relative outperformance of our fixed income investments compared to the index.  Our portfolios generally were positioned to be less sensitive to the plague of rising interest rates.  Still, trailing 3 year returns haven’t exactly shot the lights out! 

So Should I Go All In on US stocks? 

Well, sure, maybe if you are 40 years old.  Or if you are so wealthy you don’t have to worry about a severe market downturn threatening your retirement security.  Remember that from 2000 to 2003 the stock market lost almost half of its value, and didn’t fully recover for 10 years.  Those who retired with an all stock portfolio in early 2000 had a very difficult experience.  Furthermore, the runup in US stocks over the past year (which has been concentrated heavily in a handful of tech companies) has left the US stock market perhaps heavily overvalued when compared to foreign markets.  In fact, after years of under performance relative to their US brethren, foreign stock funds right now seem to be a screaming buy.  Consider that the DFA International Core Equity fund sports a dividend yield of 3.41% compared to only 1.42% on the Vanguard 500 Index! 

Meanwhile, the 3 year underperformance of bond funds was due almost entirely to rising interest rates driven by inflation.  As inflation cools, rates should at least stop rising, which means bond investors can start to enjoy the now much higher interest yield on these funds.  The Vanguard Total Bond Market ETF now spins off an interest yield of 4.4% while the Pimco Income fund yields a healthy 5.69%.  And if rates go down bond investors can look forward to a strong rally.  And since bond fund managers can lock in higher rates for years to come, investors will be able to continue enjoying these high yields long after rates on savings accounts have gone back to the low single digits. 

OK, So Maybe I Can’t Be All In Stocks – But I Still Could Have Earned More in my High Yield Savings account.  Why Invest in Risk Assets at all? 

There is nothing wrong with keeping a portion of your portfolio in money markets, CD’s, and similar cash accounts while rates are high.  But it is important to realize that these high short term rates won’t last forever.  The current interest rate environment is highly unusual in that short term interest rates (on which your bank savings are based) very rarely exceed the rate of inflation.  This only happens when the Fed is trying to cool the economy.   As they succeed, and as inflation comes down, short term interest rates will quickly follow.  So today’s high rates on savings will likely prove fleeting.  In contrast, bond funds are able to purchase bonds that lock in higher rates for 5 or 10 – even up to 30 years. 

Can’t I just Stay in Nice Safe Cash While Rates are High, then Invest in Markets if Rates go down? 

You could, but consider that if rates fall, bond funds will have already rallied – and you will have missed that boat.  At the same time, rates typically fall when the economy is slowing – and that may not be the best time to invest your money in stocks either!   Getting in and out of the market has never worked very well for investors.  Despite the occasional rough patches, staying in the diversified portfolio over the long term has always produced the best results.    

Remember Past Performance is Not Indicative of Future Returns, etc. etc.

This caveat is often used to warn investors that the nice fat past returns touted by an investment salesman should not be relied upon to continue into the future.  But likewise, we can say that it is not  to project poor recent short term performance into the future.  It might be more helpful to consider the 15 year returns of the allocation funds noted above as a reasonable expectation for the future.

Ishares Core Growth Allocation:  8.08%

Ishares Core Moderate Allocation:  6.0%

Ishares Core Conservative Allocation:  4.74%

We will generally base our financial planning projections on long  term results such as these, combined with future long term returns forecasts from major investment shops.  But it is never a perfectly smooth ride, and there will be occasional 1, 3, or 5 year periods of anemic returns interspersed with similar runs of very strong performance.  That’s the way markets have always worked.