Many Americans are placing a disproportionate amount of their savings in cash. Russ explains the perils of this excessive conservatism.
By definition, trauma leaves a scar. Fifteen years after the bursting of the tech bubble and more than eight years after the advent of the last financial crisis, many investors are still being impacted by the memory of those traumatic events.
As a result, a sizeable portion of U.S. households are placing a disproportionate amount of their savings in cash. While this is understandable, and in the short term even prudent, it comes with an enormous cost: With cash yields likely to remain low for the foreseeable future, many families will likely struggle to fund an increasingly elongated retirement.
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Market Realist – To be or not to be: cash is the question! Investors often consider cash to be a safety cushion, which is a good thing. But too much of a good thing can be harmful. Investors around the world are sitting on too much cash. The recent BlackRock Investor Pulse Survey of 2015 has found that Americans allocate a whopping 65% of their portfolios to cash while they allocate only 18% and 6% to equities (IVV) (VTI) and bonds (TLT) (BND), respectively. This can be seen in the previous graph.
The trauma caused by the financial crisis of 2008 caused investors to flee the markets, and the weight accorded to cash as a percentage of financial assets increased. As the US economy started recovering, the weights given to cash started to decline, but they began ticking up again in 2014. This trend can be attributed to the comeback of volatility to global equity markets. As the Federal Reserve contemplates hiking rates, markets are bound to relinquish their six-year-long bout of lower-than-average volatility (VXX). This, along with the heightened geopolitical tensions caused by the rise of ISIS, the European refugee crisis, and the recent violence in Paris, is causing ripples among investors.
According to the September American Association of Individual Investors (or AAII) Asset Allocation survey, individual investors decreased their stock and fund allocations to 63.6%, the lowest level in more than two years. On the other hand, the AAII reported that cash reserves had gone up to 20% for individual investors, the highest level since August 2013. Though cash reserve levels fell to 18.7% in October while stock and fund allocations rebounded to reach 64%, it still marks the second lowest reading for equity allocations in 2015 (Source: AAII, Forbes).
This phenomenon is not limited to the US alone. Cash allocations throughout the world are high. According to State Street, global investors hold 44% of their monthly savings in cash as the above graph shows.
The graph above compares the cash allocations of select countries in 2014.
In this series, we will explore why cash holds so much allure for investors and why holding too much cash may not be an effective investment strategy.