Are Safer Investments Worth The Risk Right Now?
Key Take-aways:
1. Real yield (inflation-adjusted yield) is your yield minus the inflation rate, which historically averages between 1% and 2% for risk-free assets
2. The S&P 500 from 1928 to 2023 averaged 9.8% per year (6.7% inflation-adjusted), while three-month T-bills averaged 3.3% (0.3% inflation-adjusted)
3. T-bills outperformed the S&P 500 in 31 out of 96 years (about a third of the time)
4. Reinvestment risk is important. When CDs or other fixed investments mature, we face the risk of reinvesting at potentially lower rates
5. Market timing using cash yields as a benchmark is not recommended. When alternatives look attractive, it might be a good time to invest in the market
6. Allocation should be based on your specific needs and timeline, not just maximizing returns.
7. The proper amount in cash (or not invested in the markets) can provide peace of mind, even if returns are lower
8. High nominal yields (like 15% CDs in the past) often coincided with high inflation (12-13%), so the real returns weren’t as impressive as they appeared
Are Safer Investments Worth The Risk Right Now?
Timestamps:
00:32 Risk vs. Reward in Investment Decisions
01:02 Understanding Real Yields
01:52 Historical Performance Comparison
02:25 The Illusion of “Risk-Free” Investments
05:15 Market Timing Considerations
07:35 Portfolio Allocation Strategies
09:25 The TINA Principle (There Is No Alternative)
10:15 Life Stage Considerations
11:08 Peace of Mind vs. Maximum Returns
11:38 Hidden chapter: 2025 NY Mets Predictions!
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Ben Carlson – A Wealth Of Common Sense
Safer Investments – Worth The Risk Right Now? Transcript
So the question for today is, if I can still get around 4% in money market and CDs, why should I take risk in the stock market?
It feels like we’ve been talking about this topic for a couple of years now. It first started to gain traction in, I think, around this time in 2023, when T-bills first hit 5%.
That was in the spring of 2023. Yep. Exactly.
At that point, T-bills were 5%. Inflation was running in the mid-3s.
So now, in terms of real yield — when we say real yield, that’s inflation-adjusted yield — it’s your yield minus the inflation rate. Real yield was between 1% and 2%, on risk-free savings deposits or CDs.
So there was a little bit of juice there, but rates are a little bit lower now. We’re still around 4%, but inflation has also ticked down to high 2s. So there’s still a little bit of yield left there.
But when someone asks us if – or why – they should be investing in the stock market when they can get an actual yield on risk-free investments, how does that conversation usually go?
I mean, it usually starts with what you just outlined, pointing out the difference between the nominal yield and what you’re actually getting. And just pointing out that there rarely is any “juice,” as you said.
But you know, these banks that set these rates on CDs or savings accounts, they’re not really in the business of giving away free money. They’re kind of keeping a close eye on inflation, keeping an eye on where the Fed sets their rates, and adjusting accordingly.
We’ve even seen just the online savings banks over the last year, they’ve been quick to chop down those rates as soon as rates started getting lowered by the Fed.
So it’s important to point that out to people. Most people, when they’re talking about investments or what they should do with their money, still need that growth component in their investments.
So, it’s rarely going to work out where you can set all of your money in these risk-free assets getting 4% or 3% nominally. If inflation was zero, then that would be a little bit better, but it’s usually never the case.
It’s the exception rather than the rule… this “getting the best of both worlds.”
Let’s stay with real rates for a minute. Understand that real rates of return have averaged somewhere between 1% and 2%, usually 1% to 1.5%, historically.
So, as Casey described, another way to look at this is take the rate of inflation, add another 1.5%, maybe 2% on top of it. That’s really what you should be expecting on risk-free assets, whether it’s T-bills or short-term CDs at the bank.
And so, if inflation is running at 3%, then 4.5% might be a pretty good rate that you can get at the bank, or in some type of risk-free assets. But I remember a period of time where you could get 15% on CDs.
For me, it wasn’t that long ago. It was when I got started in the business.
What a lot of people talk about those days, as if they were the “glory days,” like (the way they talk about) Mickey Mantle hitting home runs. But, you know, if you were getting 14 or 15% on a CD, there was a pretty good chance inflation was running at 12.5%, …12.75%, …13%, which we did see for a while.
And yes, in 1980 and 1981, there was a spike where we did see short-term interest rates, 30-day, 60-day paper, go to 19% and 20%. I was there for that too.
So, you will see those periods of time, those windows, where you’ll get more in a real rate of return. But it’s usually for 30 days, 60 days, 90 days — a really short-term window of opportunity, not something really long term.
There’s also risk associated with that too – something called reinvestment risk. So basically, that money is going to come due at a certain point in the future, and then you’ll have a decision to make.
Rates might be higher, they might be a lot lower. So that decision exposes you to a risk.
Forcing you to either continue to roll in a CD or savings account or something like that. Or do something different with that money.
And then, you’re exposed to what the market is doing, too. Like you said, Tim, I think it’s important to not use what you can get on cash and risk-free investments as a market-timing tool. You still want to have some exposure to the stock market in a (balanced) portfolio.
To provide some stats and some context for this, we’re going to take some numbers from Ben Carlson, who blogs at www.AWealthOfCommonSense.com from his recent post. The S\&P 500, from 1928 to 2023 averaged 9.8% per year.
The three-month T-bill for that time period averaged 3.3%. Inflation-adjusted, the S\&P averaged 6.7% per year, and T-bills averaged 0.3%.
So, barely anything for T-bills. Basically, what he’s done is he’s taken the total rate of return for the S\&P 500, reduced it by the amount of inflation over the years to get to that number.
Same thing with the treasuries. Yep, exactly.
He also added that T-bills outperformed the S\&P 500 in 31 out of 96 years. So, about a third of the time, the market was down in those years, and T-bills and cash held up.
It just goes to show that, if you just parked your money in T-bills, over the long term, inflation is going to eat away at that return, whether it’s 3%, 4%, …or 12%, like you said before. Inflation is going to eat away at that over time, and you’re going to NOT have a hedge against inflation if you put all your money in risk-free assets.
I also think it’s important to note that, just like you mentioned market timing. People want to sidestep anything that’s volatile in the market.
We’ve had kind of a sloppy market here for the last six to eight weeks. The rates that you’re getting on these savings accounts are annualized.
So, if you’re jumping in and out of the market, you want to park some money in cash for two months, or six weeks. You’re not getting that 4%. You’re getting (maybe) two months’ worth of that 4%.
So, like if it’s a monthly savings account, every time they pay it, you’re not getting paid 4% every single time they pay you. If you hold it for the full 12 months, the annualized term of the rate, then you’ll get it.
But, like you said, about a third of the time, you’re losing money compared to the stock market, which makes sense if you think about the risk premium that people talk about. So, you’re taking risk-free assets, so you’re taking zero risk.
No reward! Logically, you should get the smallest reward.
If you want to earn more, you’ve got to take more risk. Bonds are a little bit more risky than the risk-free assets. And stocks are a little bit more risky than that.
So, you expect over the long term, those assets to outperform. But I think it’s important when it comes to market timing to consider that it’s not really apples-to-apples comparing what you could get in the stock market to a couple months’ worth of interest.
I’ll also say — and this ties in nicely with a couple of videos we’ve done recently — that the historic long-term return on stocks, like Ben Carlson mentioned, is somewhere between 9% and 10%. That’s the historic long-term rate of return.
Now, a couple of thoughts: when interest rates spike, like they did in 2023 and we saw 5% CDs for the first time, some money came out of the market. That was actually a really good time to be putting money to work (in the market!).
It just seems to me, with my experience, that when alternatives look attractive, it’s probably the time that “you should be zagging” when everyone else “is zigging.” In the spring of 2023, things didn’t really look so good.
The Fed was looking like they were going to raise rates to infinity, and the market had been sliding for about nine months, and it really turned out to be a pretty good time to be putting money to work. But that also works in reverse.
One of the things I heard the week of the stock market crash in 1987 was that zero-coupon bonds, for the first time since 1982 (were really attractive). Five years later, in 1987, the yield on zero-coupon treasury bonds had broken through 9%, and depending on the individual bond, you were getting close to 10%.
People were saying, “Hey, I can now get a pretty much risk-free return almost equivalent to what I could get in the stock market over 20 or 30 years. Why wouldn’t I do that?” That’s actually a pretty compelling argument.
So, when I hear folks say, “I can get 4% or I can get 5%, why take the risk of stocks?” I think they’re forgetting that the long-term rate of return that we’re going to earn in stocks – historically – has been between 9% and 10%.
I mean, we’ve seen that just recently. Like you said, April of 2023 was when T-bills first hit 5%. Since that point in time, it’s cherry-picking the start and finish dates, but the S\&P 500 is up about 35% since then.
So, yeah, you could get some interest on your cash, but you also missed a pretty nice move in the overall market as well.
Just to go back to the reinvestment risk idea and deciding what to do with your money as it comes due. Now, just a couple years ago, before rates were where they are today, there was this concept of TINA. (There Is No Alternative)
People felt like they had to invest in stocks to gain some sort of return on their money. And I think, Tim, do you talk about this a little bit?
Just, do we have to maximize every single dollar of our plan? Right now, we don’t have to, because we’re getting a nice little return on our cash…
But talk a little bit about that and how we think about and coach people up on that.
Yeah, I think when we’re thinking about an allocation overall, it’s hardly ever “you’re doing just one thing” with all of your dollars. There’s a portion of it that can be allocated for stocks and equity growth over the long term.
Then there’s a portion of it that, depending on the phase of life you’re in, you want to have some set aside that’s not at risk in the market. You talk about risk-free assets like we’ve been talking about here, but that’s “market risk-free” assets.
It’s not eliminating all risk because you can’t do that. So if you’re trading market risk for reinvestment risk or other types of risk – just setting your money aside into cash.
For most people, it depends on when the money needs to be used. It depends on if they’re drawing down or if they are accumulating.
But for us, it’s about right-sizing the amount that’s in these different buckets, regardless of what you’re earning (on that cash). Because even during this “there is no alternative” period — it’s still worth it to have the proper amount in cash or in these risk-free assets, even if you’re earning zero or 0.3% or half a percent.
Because if you need that money liquid, if you need that money to live off of, it’s not worth trying to maximize every single dollar in your allocation. You don’t have to worry as much about the market risk; you don’t have to worry as much about what’s going on, on a day-to-day basis or a year-to-year basis even — if you know you have what you need, set aside.
So yeah, it’s all about trade-offs. You’re trading potentially some growth in the account for the peace of mind that you know your money is there when you need it, even if it’s earning essentially nothing.
Everything has a role. It’s just the best of both worlds right now, which is good for the time being. I anticipate we’ll be having this conversation with some folks, and I feel like we’ll be going over a lot of the same points we’ve talked about today.
So, do we want to do our Mets predictions in this one or in another? Let’s do it. Let’s do it.
We’re already a little late – we’re a couple of days into the season. The Mets are 1-2. We do this annually.
Mets are… we’re going to finish that for wins. Last year, I believe, Tom, you said 100.
I think I was the closest. I think I said 87.
And then Brendan and Tim were both a little low. Yeah. Brendan, who could not be on the recording today, said .500, so the Mets are going to finish 81-81.
What do you guys think? Tim?
I think they’re probably going to finish almost identical to last year. So I’m going to say 89 wins, they’ll probably get a wild card spot. These three games they’ve played haven’t really changed my opinion long-term for the year.
So I would’ve had the same answer had we recorded before the season started. But yeah, I think they’ll be pretty good.
I’m still thinking in my head like, you know, am I going to get booed if I say they’re going to win 79 games? That would be a spicy take.
But around the league, there’s consensus they’ll probably be above .500, close to what they were last year. Maybe even people are expecting them to be better.
I think the Phillies, the Braves, and the Mets have the ability to wind up in a flatfooted tie. If that’s the case, then I think all three teams will finish with 91 wins and there’ll be some kind of three-tiered playoff with a coin flip involved.
I don’t know. Like that state football championship. Yeah.
I am going with 94 wins. I’ll be the high-water mark. Let’s go!
Hey, I hope you’re right. Hope you’re right. I do too. I do too. I get the division as well. Yeah, that would be great.
We’ll circle back next year and see how these all turned out. Okay. Very good. I’m writing it down.
