Investing large sums can be intimidating. But deferring the decision won’t make it go away. In a recent episode of “The Pulse” podcast, we pulled together our best advice for investors who are finally ready to deal with their cash. You can listen here or read the transcript below, which has been edited for clarity.
Matt Palazzolo: Hi, everyone, and welcome to The Pulse, where we cover trends in the economy, markets, and asset allocation for long-term investors. I’m Matt Palazzolo, Senior Investment Strategist and Head of Investment Insights. Today’s discussion, we’ll center on cash and what to do with it. Joining me for this discussion are two of my colleagues, Aaron Bates, our Head of Wealth Strategies, and Stacie Jacobsen, a Director in our Wealth Strategies Group and a member of our Family Engagement Services at Bernstein.
Matt Palazzolo: So why are we discussing cash? Well, quite simply, investors have a lot of it today. By our calculations, money market funds surged by nearly a trillion dollars over the course of 2020 and now sit at an all-time high of $4.5 trillion. Bank deposits surged by $1.3 trillion and were also sitting in an all-time high, north of $11 trillion. And while not all that cash should be considered available for investment in the markets, a lot of it could be. And for those investors that are waiting on the sidelines, there ends up being anxiety about investing it. Think of all the risks that we’re all dealing with today, related to the economy or to the markets. And as well, the powerful force of inertia takes hold, and that influences the decisions about where to invest and how to invest. And from our vantage point, there are three main types of investors today that have money on the sidelines.
Matt Palazzolo: First, the investor that de-risked during the COVID sell-off and never really re-engaged into their allocation. Second, the investor that’s recently had a liquidity event, like a sale of a business or some other cash catalyst. And then finally, the investor that has passively just allowed their cash to build up over time—not for any reason—other than they’ve had other parts of their lives that they’ve been focused on.
Matt Palazzolo: So now let me bring in Aaron and Stacie to flesh out all of this, since they’ve both worked with clients that have grappled with this cash conundrum. Aaron, let me start with you. I laid out those three types of investors with sizable cash hoards. You work with a lot of our clients, certainly in Boston and across the globe, for that matter. Is that your experience?
Aaron Bates: Yes. And thanks for including me in today’s conversation. You know, it’s funny. I’ve been at the firm now for more than 20 years, and having lived through three major sell-offs, the first being the technology bubble bursting in the late ‘90s, 2000. The second being the global financial crisis, and then the third, I would argue, would be that March/April time period when COVID first hit the US more broadly.
Aaron Bates: And in all three of those circumstances, one of the things that I’m most proud of is that our advisor teams, collectively, have done a really good job of keeping our clients invested. However, inevitably—especially with the kind of shock that people felt in March and April—sometimes emotion takes over, and clients make the decision to move into cash. The challenge with moving to cash, of course, is trying to figure out when to get back invested. And especially when you had the elastic snap back so quickly after March and April of this past year, a lot of clients are still sitting in that cash, wondering what to do.
Aaron Bates: Which leads into the second piece, Matt, to your point, which is an investor who suddenly had a liquidity event. And they’re looking at the capital markets and seeing the stock market being at all-time highs again, and wondering when the right time is to move in. And that’s a difficult, emotional question for someone to think about. And then lastly, the reality is sometimes people are so busy working, they are not thinking about the fact that their bank accounts are getting to the level they’re getting at. I know that happens to my wife and I, sometimes. We look and we say, “Well, how did that cash end up there?” And especially after COVID, where no one’s spending any money anywhere, you wonder yourself at the end of the day, “How did this happen?”
Aaron Bates: And then there’s almost a paralysis that comes into play, in terms of what step to take next. So those are the areas that we see, not just during this COVID period, but time and time again, around major events in the capital markets.
Matt Palazzolo: Yeah, and Aaron, let me just stay with you for a second before we bring in Stacie. How do you, with your clients, think through a couple of the other elements that I’ve seen in my conversations with clients? You mentioned market being at an all-time high, but isn’t there also this issue of, “Where do I put it?” Maybe it was going to go into bonds, but bonds aren’t yielding all that much. Or just thinking through that, is that part of that conundrum that you have?
Aaron Bates: Absolutely, yes. You know, it’s funny, even when you look at this most recent period in the capital markets, where you had a major sell-off. The market came back at a roaring rate, and one debates asset allocation—and your team comes into this all the time—where there’s a debate around, “How much do I have in stocks? How much do I have in bonds? How much do I have in alternatives?” And traditionally, the bond choice is fairly easy, because your yields were at a more normalized level. Today, with yields at very low levels, the concern clients have is ultimately, what’s the worth of bonds? Why should I move my cash into bonds at the end of the day? Should modern portfolio management theory still play a role in how people think about asset allocation on the efficient frontier, for example?
Aaron Bates: It’s tough one, and we get that question all the time. I would argue that the same could be said for cash holdings today, in terms of the yield one is getting from cash itself. A difficult question. And then oftentimes, people are just looking for ideas that differ from their current asset allocation. People are looking for either the next interesting thing to invest in, or more importantly—in a period like COVID where the world has been turned upside down in many ways—what will the world look like after COVID? And might there be opportunities that arise that one is not seeing today? And people want to sit and wait and see what that might look like.
Matt Palazzolo: I think you’ve raised a lot of good points. Everybody looks at this from different angles, and none of them is wrong. They’re all appropriate, and we [as advisors] have to deal with each of these client situations idiosyncratically.
Matt Palazzolo: Stacie, let me bring you into the conversation. For all these clients, we have to get them comfortable, right? To take money off the sidelines, which is safe, how do you help our advisors to do that? What do you think about? What’s the framework that you lay out to get them comfortable moving money off the sidelines, into the markets?
Stacie Jacobsen: You alluded to the anxiety that investors now have, given the risks in the market and the economy today, and this anxiety often leads investors to paralysis. And unfortunately, that inaction can be detrimental to a family’s long-term financial wellbeing.
Stacie Jacobsen: So, one of the areas that we focus on is to try and remove some of the emotion from that decision of what to do with all that cash on the sidelines, and that is done through clear, actionable planning. The first step is to determine an investor’s core capital, and that’s the amount of wealth needed to support a lifetime of spending through periods of potentially high inflation or low market returns. And we’ll even project a longer than expected lifespan, to provide a high likelihood that our clients don’t outlive their wealth.
Matt Palazzolo: So how do you determine that?
Stacie Jacobsen: One of the components in determining core capital is an investor’s long-term allocation, and getting that right is one of the more important financial decisions that is made. It’s a balance between investing for growth while taking on an appropriate amount of risk. Now, an investor’s actions during the turbulence we experienced last year tells us a lot about their risk tolerance. If they went to cash during the depths of the market, they certainly should not be reinvesting at the same allocation. They should take a more conservative approach.
Matt Palazzolo: What tools are you using?
Stacie Jacobsen: To help us with all of this, to determine core capital and the trade-offs of these different asset allocations, we lean heavily on our proprietary analytical tool—the Wealth Forecasting System. This allows clients to pre-experience the volatility of a given portfolio.
Stacie Jacobsen: Now, look, there’s a lot of reasons why an investor may change their allocation over a lifespan, but a reaction to market volatility certainly should not be one of them.
Matt Palazzolo: Right.
Stacie Jacobsen: Our tools help us arm investors with the knowledge they need to make good financial decisions and really gives them the confidence to move forward with the appropriate strategic asset allocation.
Matt Palazzolo: So Stacie, you’ve walked through the importance of a Wealth Forecasting analysis and trying to hone in on a core capital number—or as I describe it, their bulletproof number. In your experience doing this for as long as you have, have you found that quantifying and planning for the long-term and settling on an appropriate asset allocation today gives those investors the comfort to push money off the sidelines into the market?
Stacie Jacobsen: I do. I really do. I think for a lot of investors, it’s a bit of an unknown, as to how to move forward, and what the right framework is for actually getting there. So, providing somebody with the knowledge of what their core capital is, really can help them take the appropriate steps to an investment strategy.
Stacie Jacobsen: Now, look, it doesn’t have to be done all at once, but when you really look at the long-term and over the next five, 10, 15 years, getting started is really the first right step to securing somebody’s financial wellbeing.
Matt Palazzolo: And I liked what you said earlier about inaction. Inaction is actually action. By not doing anything, you’re doing something, which is staying on the sidelines. But laying out those building blocks in the planning, I think, is certainly always important, but never more so than now.
Matt Palazzolo: And then once those building blocks are really established, it’s then logical to move to what types of investments may be appropriate for that client? I’ve found that the best place to start is with that long-term strategic allocation that client worked through using all your analysis, Stacie. They figured out their core capital number. They’ve got money on the side. The first right place to go is to just push it into that allocation. But from time to time, that long-term strategic allocation may not be the place that that client wants to put their capital, and that’s okay. I’ve found that when an investor wants to be slightly different from their long-term allocation, they end up deciding that based on a couple of characteristics of what might be appropriate for an investment.
Matt Palazzolo: Those decision points are: Do they want to be contrarian or not? And can they be illiquid or not with that investment? If they’re not going into their long-term strategic allocation, they’re generally thinking through those two decisions there. Contrarian or not? Illiquid or not? And within each of those categories...for example, illiquid and contrarian, there’s several different asset classes or strategies that may be a fit for a client. I call it a decision tree.
Matt Palazzolo: Let me come back to you, Aaron, now that we’ve helped think through a framework for the where. I think the how is also increasingly important. How do I get invested? And you mentioned that some of your clients are worried about the market being at an all-time high, or other risks. How do you get comfortable helping them think through the how to get invested? Do you do a dollar-cost averaging? Do you push it in all at once? What’s that conversation sound like with your clients today, Aaron?
Aaron Bates: It really is personality driven. And I say personality-driven because the analogy I think about are two of my three kids. My oldest daughter is very cautious. When we’re at the beach and she’s going in the water, she likes to walk in. She’ll jump the wave a little bit, and then she’ll get comfortable and be out on the sandbar. My middle child just runs right into those waves. They both end up at the same place on the sandbar; one just takes a little longer. They both have a great time, once they’re out there. It just takes a little while to get out there for one of them, versus the other, and it’s a comfort factor.
Aaron Bates: So, I think this really comes down to understanding the comfort factor of a client and making sure that we walk them out to that sandbar in a way that makes them enjoy themselves once they’re there.
Matt Palazzolo: I love that analogy. That’s perfect. I’m going to use that from now on, just so you know. But it’s absolutely right. They both have a great time once they’re in the water, but one child is just going to take a little bit longer. One investor’s going to take a little bit longer, but ultimately, if you’re in the water, if you’re invested for long enough, you get the same results.
Stacie Jacobsen: Hey, guys, I’m going to jump in here on this one, as well, and continue with that analogy, because there were investors who I’d say are playing in that shallow end of the water there. And they saw waves coming in, and they were just too big, and they jumped right out. And that can potentially be detrimental. They haven’t gotten back in yet. And one of the things that we’d want to focus on is make sure that we get that right long-term asset allocation. Because clearly, the allocation wasn’t right if it was something they felt they had to get out of—and they should likely be much more conservative.
Matt Palazzolo: Right. Stacie, I know you’ve done a lot of analysis and work on the cost of delaying investment. And I’m not talking about delaying for a couple of months, like Aaron’s daughter tiptoes in. I’m talking about longer periods of time. Can you just describe that analysis and your conclusions?
Stacie Jacobsen: Yeah, so I’ve done a lot of work on the impact of delaying. And as you said, it’s not just a couple of months, but it’s for really a couple of years—and it’s substantial. And so when we talk about the concept of core capital, that’s really if you start an investment strategy today or in the next couple of months. But if you say, “Hey, you know what? Thanks for that number, but I’m going to implement this strategy a few years down the road,” well, I’ve got to tell you, that core capital number does go up quite substantially.
Stacie Jacobsen: So again, the benefit is getting started and getting started at a reasonable period of time. And that will really be the thing that secures your financial future.
Matt Palazzolo: We’re going to have to leave it there. And I want to thank Aaron and Stacie for their insights today. This is obviously a timely topic. With money looking to be put to work in the markets, investors need guidance, and they need advice about the where and the how. We hope that this conversation provided you with some perspective from the three of us, each of which is helping clients grapple with this conundrum every single day.
Matt Palazzolo: I also want to make you aware of two recent blogs we’ve published for specific audiences with an abundance of cash. The first is for entrepreneurs who have just come into a windfall from selling a business, and the second helps executives with large concentrations in public company stock. In that case, holding cash doesn’t offset single stock risk in the way that you’d think.