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It wasn't that long ago that investors earned virtually 0% return on their money.
Because the Federal Reserve keeps interest rates high to combat high inflation, you can easily earn a 5% annual return on savings accounts and other low-risk investments.
Some experts are now warning that it is possible to place too much faith in those super-safe returns and miss out on higher market returns.
“We're too obsessed with cash,” said Callie Cox, chief market strategist at Ritholtz Wealth Management, wrote last week in a blog post.
It is estimated that $6 trillion in cash is parked in money market funds.
Industry research shows that younger investors, who have the longest investment horizon to absorb risk, invest the most in cash.
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More than half — 55% — of wealthy younger investors aged 21 to 43 have increased their cash allocations over the past two years, compared to 46% of individuals aged 44 and older. recent research from Bank of America found.
While Bank of America focused on investors with at least $3 million in investable assets, trading and investing platform eToro found earlier this year that younger investors are twice as likely to have investable assets as their parents' generation. increased their liquid assetsThe eToro survey polled 1,000 US retail investors as part of a larger group of 10,000 across 13 countries, and respondents owned at least one investment product.
“A bigger problem that not enough people are talking about is the fact that younger investors are investing too much money because of the allure of the 5% savings rate,” Cox said in an interview with CNBC.com.
“Underinvesting is a risk, and I think younger investors are sensitive to that,” Cox said.
'Day of Judgment' for Savers May Be Coming
Over the long term, a 5% return may lag behind the potential gains investors can make from stocks. A more aggressive portfolio allocation to stocks may 7% average annual return. Some years it will be higher and others lower.
The S&P 500 index could rise to 5,800 by the end of this year, taking its total return for the year to more than 20%, said Thomas Lee, managing partner at research firm Fundstrat Global Advisors. told CNBC's “Squawk Box” on Monday.
That would follow a 24% return for the index in 2023, he noted, bringing the total for both years to about 50%. That would be “painful” for cash investors who missed out on those gains, as it would take them 10 years to achieve the same results, Lee explained.
“I think the end of this year will be a bit of a reckoning for those who said, 'Oh, I'm happy with my $6 trillion in cash yielding 5%,' when in reality growth can continue for quite some time unless the economy goes into recession,” Lee said.
Not all experts are so optimistic, however.
Research firm BCA Research predicts the S&P 500 could fall more than 30% later this year if a recession hits.
How much savings you need
Of course, all investors should set aside some money, experts say. Financial advisors generally recommend having at least three to six months of expenses in cash for emergencies.
Research often shows that many Americans fall short of that goal. Americans have a median emergency savings of only $600according to a recent study by financial services company Empower.
Of Americans who do have savings, 67% still earn less Bankrate recently found that this percentage is higher than 4% annually.
According to Cox, it makes sense to set aside money for goals that are one to two years in the future, or even three to five years in the future, so you know the money will be there when you need it.
“But if it takes longer than five years, I would seriously consider putting that money into equities or other riskier assets,” Cox said.
Market timing is 'a fool's business'
Fear may be one reason why investors are now inclined to sit on the sidelines with cash.
But experts say the risk of missing out on positive market action could be a bigger opportunity cost.
“Market timing is truly a fool's errand, but not participating in the market is equally foolish, especially for long-term investors,” said Mark Hamrick, senior economic analyst at Bankrate.
While there is always the possibility that markets could continue to rise indefinitely or fall by 50%, those are the exceptions, Cox said.
“If you only hold cash, it can take a long time for that decline to occur,” Cox said.
The biggest risk for investors now is missing out on another leg of the rally, she said.
The climate for cash savings may be about to change as the Federal Reserve has announced plans to eventually begin requiring cash savings. lowering interest rates as inflation falls.
That could make 5% returns on cash a thing of the past. Savers can lock in five-year certificates of deposit at current rates, Hamrick said. But they should be aware that they will have to pay a penalty if they want to access that money sooner than five years, he said.
“Yields on CDs, high-yield savings accounts, money market accounts and the like remain high,” Hamrick said. “Rates will likely come down, but not like a rock, but like a feather.”
