The Cost of Cash

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Stacie Jacobsen: [00:00:00] Thanks so much for joining us today on The Pulse by Bernstein, where we bring you insights on the economy, global markets, and all the [00:00:15] complexities of wealth management.

On today's show, we're looking into the benefits and costs of holding investments in cash. I'm very pleased to have as our guest today, Maura Pape, a senior investment strategist at Bernstein.

But first, let's take a pulse of the market. [00:00:30] Turning into the second quarter, investors have started to ask what has changed since the Silicon Valley Bank failure?

This is what we already know. Expectations for the policy rate path have come down, as have yields, which are pricing and lower fed target rate, [00:00:45] and a flight to safety.

Inflation expectations have also eased. There's likely more. We don't see this as 2008 all over again, and what's likely to ensue for the banks are lower profitability, higher regulatory cost, and [00:01:00] less appetite for lending.

Now, only time will tell, but we'll be watching demand for liquidity from banks closely.

And now onto today's episode, we're talking about holding investments in cash. It might be helpful to understand what we mean by the word [00:01:15] cash.

While it doesn't exclude money held in deposits in banks, it also means investments in money market funds. These investments have several features in common.

Such as daily liquidity, low risk, and usually comparatively low returns. [00:01:30] Volatility is very limited, so basically a dollar in does equal a dollar out.

More broadly, certificates of deposits or CDs and other very short duration investments can also be part of this cash management solution. [00:01:45] But these either require the investor to give up some liquidity or take on some volatility.

Now over the last decade or so, cash tended to be the un favored investment of the financial markets with interest rates at rock bottom prices.

Meanwhile, other [00:02:00] investments like equities and longer duration fixed income products did generate better returns, but only when the wider markets were highly volatile and offered the prospect of loss of principle, then cash regained.

In the last year, the Fed's rapid rate [00:02:15] heights did change this dynamic, increasing returns on cash.

So, money market funds that are now offering in the four and a half percent range are looking pretty good, but is settling for only that short-sighted and the last few months.

Inflation has fallen from its recent [00:02:30] highs, but the most UpToDate consumer price index reading of 5% means that cash investments are struggling to even keep pace with inflation.

Let alone better it. So what are some of the options for long-term investors who are currently sitting on cash?

Stay tuned for more after [00:02:45] the break where we'll sit down with Maura Pape to talk about cash held in your portfolio.

I'm Clare Golla, host of Inspired Investing, a podcast for those engaged in philanthropy and the broader social sector.

Check out our latest episode with [00:03:00] Dan Pallotta, entrepreneur, innovator, and bestselling author of Uncharitable, which offers an unconventional and perhaps controversial take on philanthropy. Listen to inspired investing on your favorite podcast platform. [00:03:15]

Welcome back to The Pulse by Bernstein. I'm your host, Stacie Jacobsen.

Our guest today is Maura Pape. She's a senior investment strategist at Bernstein. Welcome, Maura.

Maura Pape: Nice to be here.

Stacie Jacobsen: Thanks so much for joining us. You know, the recent events in the banking [00:03:30] sector in general have prompted some investors to take a closer look at their cash. Can you tell us what do they really need to know?

Sure. So, 10,000-foot view. Why do investors want cash? First and foremost, they're looking for safety, stability, and [00:03:45] liquidity. This is the money that you're going to spend in the next year. It's your rainy-day fund. You want it to be there immediately when you need it. If you can tick off all those boxes in only if, then you're going to look for a little bit of yield.

[00:04:00] Try to get some return on that. What happened recently in the banking turmoil? It was really a wakeup call for investors to be more conscious about how their cash is protected and. Also, for the opportunities that are now [00:04:15] available to get a better return. The policy response was swift and substantial, both from the public and private sector, and we don't expect these acute events to continue.

Nonetheless, a lot of investors, even those who weren't [00:04:30] invested in these banks, are saying, what are our best practices for cash management? Should we have some redundancy? How should we be thinking about. Secondly, it was a catalyst for realizing that there's some yield to be had on cash.

Now, [00:04:45] that's your typical cash held in a bank deposit, and then there are money market funds too.

Maura Pape: I mean, people throw these terms around a lot, but basically investors can go out and own an asset, which is a diversified pool of very [00:05:00] liquid debt securities. Often this is from governments or from municipalities, and the rates on these securities float as interest rates go higher. So, we all know what happened last year.

The fed raised rates rapidly. [00:05:15] Deposit rates, what banks are paying you, they didn't go up by that much. Banks really drag their feet because that's how they're going to make money. But on money market funds, you can now find yields that are in the range of four and a half, 4.75%, which is [00:05:30] very attractive.

So these money market funds, which offer daily liquidity, very safe. You know, someone is custodying and holding that asset for you are an increasingly attractive option for investors looking for a place to [00:05:45] put their cash and earn a little bit of money to.

Stacie Jacobsen: Yeah, I'm glad you just went there because I think for many investors earning a return of somewhere in the four and a half range just on cash actually feels really good.

So what are the, some of the arguments against [00:06:00] holding money in cash?

Maura Pape: You're right, that sounds great. Uh, especially for more nervous investors, 4.75% and very little risk. Sounds awesome. There is a place for cash, and it's great that we have a return on cash like this right now [00:06:15] for money that is not necessarily needed in the next year, that you won't need overnight, your longer-term funds.

There are just better opportunities to earn more money right now, and one of these opportunities is high quality [00:06:30] municipal bonds. Stay with me. That might not be the very exciting answer that you want. Sort of the point right now that you can actually earn money from these very safe, secure assets.

Municipal credit is as good as it's ever been. [00:06:45] If you talk to our municipal bond team, they'll tell you that states have large rainy-day funds. These securities are backed by the municipalities ability to tax or buy special projects like toll. Uh, so investors can feel [00:07:00] secure in investing in these types of bonds.

The other thing that might be a little bit more exciting is the tax benefit of municipal bonds. Mara, what are those tax benefits? So, when you're comparing, you know, the yields you see [00:07:15] on money markets or even on CDs, you want to think about how much of that yields are you actually going to get to keep?

What is going to go in you. And for municipal bonds, you're not paying federal taxes. And if you're investing [00:07:30] in bonds of the state that you live in, you wouldn't be paying state taxes either. So, you're still going to be taking home more money if you're in a high tax bracket from a portfolio of, um, intermediate term high quality municipal bonds than you [00:07:45] would from cash.

That's such a great point, especially for investors in high tax states because often the rates that are compared are pre-tax and not the amount that you actually keep. So, thanks so much for reminding us of that. So, you know, if an investor does have [00:08:00] cash and they're starting to want to dip their toe into the market, whether it be equities or bonds, how do you suggest somebody starts.

Sure. And, and just to be clear, this is all taking on a little more risk than money market funds, and we're conscious of that. But for your [00:08:15] long-term capital, that's, that's what you should be doing. We have a lot of investors who come to us right now and say exactly what you just said. It feels a little scary out there.

Uh, I don't know if I can go in all the way. What's a way that. Get started, [00:08:30] and this is especially relevant for people who came into some type of a lump sum in inheritance, someone who just sold their business. It feels like a lot at once. Uh, so we really want to first and foremost make sure that these investors are [00:08:45] comfortable with getting into the market because the worst thing you can do, Not stay to the plan, get uncomfortable, divest at the wrong time, and not stick to the allocation that will be most beneficial for you.

Stacie Jacobsen: Uh, we did recently have an [00:09:00] episode on Active ETFs and I found that a tool investors find attractive right now, um, are either defined outcome ETFs or buffer ETFs.

Maura Pape: This one in particular has options inside, um, but still trades in the market every day. [00:09:15] And what it does is it narrows the range of. That will occur over the next year for an investor's investment in this.

Stacie Jacobsen: So, Mara, I want to back up for just a second. What do those actually mean?

Maura Pape: What that actually means is that an [00:09:30] investor is protected for some portion of the downside. On a price index like the s and p 500, it could be around 15% in exchange for capping out their. So, if the market were to fall anywhere [00:09:45] between zero and 15%, an investor would be about neutral.

And in exchange for that, there's that cap on the upside. But right now, Caps are in the mid-teens range, and a lot of investors are saying, hey, if I can [00:10:00] participate and get 10% or 12% or even 15% and know that I have that buffer on the downside, that sounds pretty good to me.

Stacie Jacobsen: And then what happens after that down 15% buffer?

Maura Pape: Then the investor does [00:10:15] start to absorb the loss. And that's a good point because in the worst-case scenario, you will, if, if it's down 20%, you will be down around 5%. Cuz we want to take into account fees, but it won't be as bad as what the market is down. So if an investor [00:10:30] is ready to get started, but it still just feels too daunting to do it all at once.

Stacie Jacobsen: Can you talk us through the idea of dollar cost averaging?

Maura Pape: Sure. I mean, this is a great tool that some people use even automatically if you're investing a little bit out of every paycheck. It's a [00:10:45] great way. To have discipline and at the same time, um, by buying the same dollar amount of securities every same month, you're automatically buying more when the market's down and buying fewer shares when the market's more [00:11:00] expensive.

So, this is a great practice to have for any cash inflows that you're getting in on a regular basis. For those other investors who are sitting on a more, a lump sum of. A pool of cash they haven't yet invested. The calculation's a little bit [00:11:15] different and we want to be careful to weigh both the benefits and the risks of dollar cost averaging at that point.

So, markets usually rise over time. We want to be conscious of that when we're thinking about pace of entering the market. Uh, the [00:11:30] benefit of dollar cost averaging isn't necessarily to get a better. But it's to provide some reassurance and to make sure people really feel comfortable with their entry so they could stay on the plan.

Stacie Jacobsen: I think of dollar cost averaging a little bit like insurance. [00:11:45] So if the market does go up, it's going to cost you a little bit to go in over time, but if the market is going down, it will help to reduce that downside risk.

Maura Pape: That's exactly right, and I think that's really important for people who are maybe new investors.

And who are thinking [00:12:00] about how they can really get their head around this new risk that they're taking on. But the market does go up more than it goes down. So we would want to think about that in terms of setting out the timeline for dollar cost averaging. And our research suggests [00:12:15] that you should keep it under six months because then at that point, uh, you're giving up a little bit too much of the upside, whereas you could have been invested on getting the market return.

Uh, you don't wanna be on the sidelines for too long. All right,

Stacie Jacobsen: Mara, [00:12:30] for newer investors entering the market who don't necessarily have the appetite for the public market volatility, what are some options for them?

Maura Pape: That's a good point, Stacy, especially newer investors, business owners, we hear this a lot from, they were just, In [00:12:45] charge of their biggest investment for so long.

It feels like a big leap to give up that control and then see these numbers moving around when you pull it up on your phone every day. But there are options for that. And in the suite of alternative investments, [00:13:00] we see a lot of opportunities right now. Additionally, in private markets because of the dislocations in liquidity, we are seeing it as an especially attractive entry point for some of these strategies.

When I talk about liquidity dislocations, [00:13:15] all I basically mean is that right now there's a little bit less liquidity in private markets for various reasons. Private market investments have done better than public market investments in the last year or. So, some [00:13:30] investors need to rebalance that from the, you know, investments that have done well to public market investments.

Additionally, with a potential pullback in lending from other sources like banks, you could see less competition. [00:13:45] Alright, can you give us an example? So, in private credit, if banks aren't going to be lending as much, if other investors are putting a priority on liquidity, because you do need to give up liquidity to consider these investments.

That's an [00:14:00] opportunity, uh, to be taken advantage of for people who can do the proper underwriting. You can get higher yields, higher spreads, and even better terms and covenants on yours.

Stacie Jacobsen: Right. Great point. Look where we are today. What are [00:14:15] some of the areas that investor can be opportunistic given the volatility in the markets?

Maura Pape: That's a great point you bring up, Stacie. Every time there's dislocation and turmoil in the markets, there are also areas of opportunity. We mentioned core bonds [00:14:30] and defined outcome ETFs for investors who want to be a little bit more. Uh, there are also investors who may be interested in jumping into certain areas of the equity market where valuations are discounted.

One of these, which is particularly [00:14:45] interesting is micro-cap banks. Yes, I said banks that can make investors a little bit nervous to hear that right now, but I think one of the most interesting things about what's going on in the financial sector is [00:15:00] how bifurcated the effects have. We've seen deposits flowing into the larger banks, the systematically important ones that investors have a lot of trust in.

Um, but we're also hearing from the CEOs of smaller banks [00:15:15] that their deposits are staying put. They're at smaller levels. They're insured by the FDIC, their community banks, where people still have a. Faith and trust in them. These banks are also cheap right now, uh, which shouldn't be surprising to [00:15:30] anyone who's been watching the market.

And additionally, there has been a trend towards consolidation. If you just think about the amount of regulations that banks have to deal with now, it makes a lot of sense to put smaller banks together and do one [00:15:45] pile of paperwork instead of two. You're buying an asset that's cheap with the potential for a little extra idiosyncratic return for mergers and acquisitions because banks usually get taken out at a premium.

So, we do see some of these [00:16:00] interesting areas of, of opportunity. You just have to look for them.

Stacie Jacobsen: Now with a mild recession likely on the horizon and the positive performance of the equity market so far this year, some investors may be thinking that now is the time to move to [00:16:15] cash. Mara, how would you respond?

Maura Pape: You know, Stacy, we do think the equity market in particular has run a bit ahead of itself so far this year, and we expect some choppy performance. Our investors, [00:16:30] however, are investing for the long term. They're not just investing from, you know, may until December. And for these long-term investors, we don't think it makes any sense to try to time the market.

That actually means getting it right twice, [00:16:45] getting out at the right time, and then getting back in at the right time. We've done a lot of research and even missing. Best couple days can really have a detriment to your long run return. So, I think really the point here is [00:17:00] stay in your strategic allocation.

The one that you set up with your advisor that's most likely to meet your long-term goals and keep your eye on the ball for the long-term markets are forward looking. So even if we do expect a mild recession this year, [00:17:15] At some point, as we get towards the end of the year, we expect to see a better investment climate at that point for the equity market.

Stacie Jacobsen: Yeah. And you mentioned the cost of missing just some of the best days, um, but some of the other hidden costs, right? The transaction costs, the potential [00:17:30] taxes, and then to your point, having to get it right twice and when do you reenter the

markets?

Maura Pape: That's right. All of those things add up to it making the most sense to just stick with the plan, even if it.

Feel comfortable all the time.

Stacie Jacobsen: Mara, thanks [00:17:45] so much for joining us today. Thanks, Stacie. Happy to be here.

And thanks to everyone for tuning in. You'll hear from us again on May 9th when we'll have a segment with Adam San from the Big Stage. You won't want to miss it. And don't forget to subscribe to The Pulse by Bernstein wherever you get your [00:18:00] podcast.

To ensure you never miss a beat. I'm your host, Stacie Jacobsen. Wishing you a great rest of the week.