After both stocks and bonds took a beating in 2022, investors may be wondering if cash is the best asset to hold in 2023.
Holding cash has certainly become more appealing lately. After a series of extra-large rate hikes, the federal funds rate is the highest it's been in 15 years, and the Fed plans to further raise interest rates in 2023. That translates to some attractive yields on cold hard cash. Some banks are paying over 4% on a savings account.
Despite the attractive yields available for a simple savings account, there are very few reasons holding cash makes sense for most investors.
Timing the market?
If you're a long-term investor, it rarely pays to try to time the market.
Cash is historically a drag on investment returns. That's why strategies like dollar-cost averaging a lump sum instead of investing it as soon as possible underperform on average. If you're looking to maximize your returns over the long run, it makes sense to invest the cash in stocks or bonds instead of holding onto it.
If you're waiting for the right time to invest with the expectation that markets will continue declining in 2023, you might be able to get your money into the markets at a better price. But that better price may never come, leaving you on the sidelines as markets recover.
Trying to time the market has its costs, and those costs often outweigh the benefits.
It's practically impossible to predict the short-term trajectory of the stock market. Over the long run, however, assets should increase in value in a manner commensurate with the risk associated with the investment. So, a relatively risky asset like stocks will come with an outsized return versus a low-risk asset like cash. Therefore, long-term investors should move cash to stocks as soon as possible (as long as it's within their risk tolerance).
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Who should hold cash?
There are instances when holding cash could make sense for some investors.
First, retirees will likely want to hold some cash to fund their regular expenses. Perhaps that comes out of their investment portfolio at the start of every year.
Likewise, if you have short-term savings goals -- saving for a house, car, or a gap year, for example -- holding cash isn't a bad idea. Considering you can get a good yield on your cash reserves these days with a simple savings account, you'll still be able to collect a meaningful amount of interest.
Basically, if you expect to make withdrawals from your portfolio in the next year, holding cash is certainly acceptable, if not advised.
Better options than cash?
If your situation requires you to hold cash instead of investing for the long term, there may be some better alternatives, though.
You may want to buy Treasury bills from the U.S. Treasury. You can buy T-bills with durations as short as four weeks. What's more, the interest earned on T-bills is exempt from state and local taxes, which may produce a better effective return than interest on a savings account, which is fully taxable.
For those looking to beat inflation, you could invest in Series I savings bonds. I-bonds are marked to inflation plus a nominal interest rate. You have to hold them for at least one year, and you'll pay a penalty of three months' interest if you cash them before five years. Still, with current inflation rates, you can get a better return with I-bonds than with any savings account. Again, interest is tax exempt at the state and local level. The only drawback is an investment is limited to $10,000 per person per year.
So, even in situations where it might make sense to hold cash, there are often better alternatives that can provide practically as much safety with better returns.
