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The Opportunity Cost of Holding Cash

Holding cash may seem like a safe harbor in the financial markets, providing liquidity and peace of mind. However, this comfort comes with a hidden price – the potential growth you miss out on when your money isn't working for you. With each passing day, your cash reserves could be foregoing valuable opportunities to earn interest, dividends, and capital gains. Over the long run, money market funds (a proxy for cash) have underperformed other fixed-income allocations. Even short-term fixed-income treasury notes have outperformed cash over the long run.

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Does [fill in the blank] Belong in My Portfolio?

Financial innovation provides investors with a seemingly endless supply of new investment options. But the process of evaluating the merits of these investments remains the same even as the names change. Adopting a new component in one’s asset allocation represents a tradeoff that should carefully balance the expected benefit vs. the cost of its inclusion. The following framework highlights benefits investors may seek as well as potential drawbacks—a checklist that applies to any investment opportunity.

Properly evaluating whether something belongs in your portfolio begins with specifying the role it is expected to play. These roles come down to a) increasing your expected return or b) helping manage risk.

If the objective is to increase expected returns, what is the case for the asset in question accomplishing that? It is easy to link a positive expected return with equities, for example, as stock ownership gives you a claim on companies’ future cash flows. Similarly, bondholders expect to receive periodic interest payments and the return of their principal as stipulated in the bond’s covenant. But an asset that lacks a sound foundation for delivering a positive expected return should give investors pause, regardless of its past performance.

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Six Life Lessons That Also Apply to Investing

 No matter how familiar you are with investing, you’ve navigated uncertainty, weighed risks and rewards, and made carefully considered tradeoff decisions. You’ve tackled the central challenges of life — which also happen to be the central challenges of investing.

Having a good investment experience is about more than returns. It’s about how we feel along the journey. Investing should help us live better, more fulfilling lives. By integrating our life and investment philosophies, we can see money as a tool that empowers our plans rather than as a goal in and of itself. Here are six principles that can help us in life and investing.

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Magnificent 7 Outperformance May Not Continue

The Magnificent 7 stocks continue to capture the focus of investors as these large growth names have outpaced the bulk of global equities. Their outperformance is notable because eye-popping returns for top stocks tend to occur before they reach the top of the market. Once there, subsequent returns tend to lag the market.

This is a cautionary tale for investors expecting continued outperformance from the Magnificent 7. In fact, rather than seeking additional exposure to these mega-cap stocks, investors should ensure their portfolios are broadly diversified to capture the returns of whatever companies ascend to the top in the future.

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Country Debt and Stock Returns

US government debt reached 121% of the value of the country’s gross domestic product (GDP) last year. Many investors have expressed concern over the impact that servicing this level of debt could have on the stock market. But the historical data show little relation between the two. Since 1975, there have been 153 observations of a country exceeding 100% debt/GDP for a year. Stocks were up for that country/year in 104 of the 153, or about two-thirds of the time.

There are numerous examples of countries carrying high debt for extended periods. Italy and Belgium have both been over 100% debt/GDP in more than 30 of the past 48 years. Meanwhile, their stock markets have returned an average of 10.8% and 12.0% per year, respectively. Japan has been over 200% since 2010 while its market averaged close to 6% per year over that period.

Stock markets set prices to the point where investors have a positive expected return given current information. Country debt is a slow-moving variable, so it’s sensible that current prices reflect expectations about the effect of government debt. And it’s unsurprising to see stock performance has generally been positive even amid high-debt conditions.

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Stocks Can Still Go Up if the Government Shuts Down

 

The US government temporarily averted a shutdown after the House and Senate passed a 45-day funding deal on September 30. But the specter of a shutdown still looms if a longer-term funding resolution fails to materialize before the stopgap ends.

The US government has faced 14 funding gaps since 1981, 10 of which resulted in shutdowns.

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