In the United States, money market balances have gone from under US$3.5 trillion to US$4.6 trillion so far in 2020, according to Refinitiv Lipper data. Commercial bank balances have gone from US$13.3 trillion to US$15.5 trillion over the same time period according to the Federal Reserve Bank of St. Louis. Essentially, over US$3 trillion has moved into cash and money market funds since January.
To put that number into perspective, it would represent just about the entire market value of Apple and Microsoft combined, the two most valuable companies in the world.
In Canada, we have statistics from the Investment Funds Institute of Canada, which tracks mutual funds and ETFs. The end of May number for money market ETFs and Mutual Funds was $43.6 billion compared to just $30.3 billion one year earlier. Following the U.S. statistics, I would imagine that bank balances have seen a spike of much more than $13 billion in Canada.
There is certainly some good reasons to hold cash and money market funds. They are safe and liquid. If you have short-term needs for the funds or as a safety cushion or for ongoing operations of a business, this is a very valid option. However, as a choice for long-term investment it has not proven to be wise.
When I see a spike in these balances, this spike represents an investment decision. This is people and businesses choosing to be in cash rather than other forms of investments. Today, these trillions of dollars are likely earning somewhere between zero per cent and one per cent. I know that it is possible to earn higher rates at very small companies or by locking your money away for a period of time, although locking your money in removes the liquidity benefit.
Of interest, the largest money market funds in Canada have an annualized 10-year return of less than one per cent.
If most Canadians expect long-term investment returns of five-per-cent-plus, and money market funds have not provided one per cent over the long term, the only reason to have long-term money in a money market fund or bank account is either fear or a true belief that you are able to add value through timing of getting in and out.
Timing the market effectively by moving to cash is possible, but for most it isn’t effective, if for no other reason than markets go up over time. However, there is another reason why timing the market is usually not effective. If we look at actual monthly data from 2009, looking at money market balances in Canada and the performance of the TSX 60, we see that investors missed out on much of the rally.
In March, April and May 2009, the TSX 60 was up a total of 26.8 per cent. Money market balances peaked at the end of March and declined a total of 1.7 per cent over the same three-month period. This means that from an all-time peak in money market holdings, only a tiny percentage of investors had reinvested in time to take advantage of the big rebound. From June 2009 to January 2010, the eight months following the big gains, the TSX 60 was up 3.2 per cent. What happened to money market? Balances dropped 35 per cent, or $23.5 billion moved from the safety of money market back into some form of longer-term investment. No issue with it moving back out, but they did so after missing out on a major part of the recovery.
I had mentioned earlier that the only reasons to move long-term investment money into an asset class that is guaranteed to underperform your long-term goals is either fear or a true belief that you are able to add value through timing of getting in and out. The reality is that most investors bail and put funds into cash after at least a meaningful portion of losses have taken place. As seen in the 2009 recovery, they then return this cash to investments after most of the big gains have already happened. Essentially, most investors do not add value to their portfolios by switching to cash and then reinvesting. This leaves one reason to shift to cash. That is fear.
I don’t think I need to review the reasons why fear is not conducive to strong long-term investment returns. If you look at the table below, it shows returns for 25 years to Dec. 31, 2019. The returns are similar for any longer-term period. Of these asset classes, the only thing we know about the future is that U.S. T-Bills will produce a lower return than 2.5 per cent over the near future. The bottom line is that cash, money market, and GICs are not good for your long-term investment returns.
What are the better alternatives to investing in cash today? Almost everything. This isn’t a comment on the direction of the stock market in the short-term, but rather a comment on long-term investing and the inability to predict the future — especially in the short-term.
If we just look at dividend and other income yields, we will see a range, but all are higher than the returns on cash. As for growth beyond these yields, we can just put our faith in long-term history. For reference, I have also shown the private credit yields available through TriDelta’s Alternative fund at the high end of the range.
As a final thought, history tells us that big shifts in cash are short term. When trillions of dollars roll back into the market (which they will), do you want to be at the front end of that rush where you can benefit from the dollars that come behind you, or the back end.
If you are sitting on oversized positions in cash and money markets today, the best course of action is to get back to normal.
Ted Rechtshaffen, MBA, CFP, CIM, is president and wealth adviser at TriDelta Financial, a boutique wealth management firm focusing on investment counselling and estate planning. You can reach him at email@example.com.