Here’s the danger for investors in holding too much cash, says Wells Fargo

For the first time in ages, it pays — even after inflation — to hold cash. But high yields could disguise a pitfall for investors, warned an investment strategist at the Wells Fargo Investment Institute.

In May 2023, the yield on the 30-day U.S. Treasury bill topped 5%, and remains so. It stood at 5.384% late Tuesday morning. Certificates of deposit and high-yield savings accounts paying north of 4% can be found. Meanwhile, inflation as measured by the consumer-price index has fallen from a mid-2022 peak of 9.1% year over year to 3.2% as of July.

As the chart below from WFII shows, cash yields moved into positive territory on a real, inflation-adjusted basis after a few years of negative real yields.

The shift to a positive, real cash yield environment has investors wondering if it’s time to increase cash holdings or hold on to cash as they await better opportunities to enter the market, said Veronica Willis, a WFII global investment strategist, in a Monday note.

Related: Investors parked heavy in cash may be making a ‘mistake’, Nuveen says

But parking too much of a portfolio in cash can have “unintended consequences,” Willis wrote. The problem, the strategist said, is that even if cash yields remain elevated in the short term, history shows cash is likely to underperform other growth assets over the long term, acting as a drag on long-term performance.

Several strategists, meanwhile, have argued that longer-dated bonds may be poised to outperform if the Federal Reserve proves to be at or near the end of its rate-hiking cycle.

See: Investors skeptical about a ‘soft landing’ are more bullish on longer-dated bonds

The 10-year Treasury yield
BX:TMUBMUSD10Y
hit its highest since 2007 earlier this month, but has since pulled back. It dropped 8.9 basis points Tuesday to 4.121%. Yields and debt prices move opposite each other.

Stocks ended higher on Tuesday, but have seen a 2023 rally suffer a pullback in August. The S&P 500
SPX
jumped 2.5% in Tuesday’s session, while the Dow Jones Industrial Average
DJIA
gained nearly 300 points, or 0.8%.

History has shown that even a very conservative allocation, such as “moderate income,” has returned more than cash over long periods of time, Willis said (see chart below).

A diversified allocation tailored to an investor’s goals and risk tolerance can be more effective at capturing the upside return potential of growth assets while also smoothing volatility compared with a concentrated position, Willis wrote.

“While we do not expect a return to the ultralow cash yield environment of the last decade or so, we do expect every strategic asset class to outperform cash over the long term based on our capital market assumptions,” the strategist said.

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