Christine Benz of Morningstar says investors with short spending horizons may favour cash, while longer horizons can shift more toward bonds and equities.
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Cash and bond yields are at their highest levels in more than 15 years, prompting questions about how to balance stocks, bonds and cash in a market where 5% CD yields are available, according to Morningstar personal finance director Christine Benz.
Benz said holding extra cash can appeal to investors because cash investors have no potential for principal volatility, and cash has been shown in Morningstar’s annual diversification research to be a solid diversifier for equities, on par with bonds.
She cautioned that cash yields may not last because cash investments are short-term loans to various entities, meaning high yields can disappear if interest rates drift down and higher-rate loans are retired.
Benz added that yield can also fluctuate for investors using money market mutual funds or high-yield savings accounts, since those returns move with the prevailing interest-rate environment.
Inflation risk is another concern, she said, noting that long-term cash returns may be lower than bonds and that inflation can take a larger bite out of cash payouts over time.
On why buy bonds rather than cash, Benz said buying a bond with a longer maturity can lock in an interest rate for a longer period, and bonds also have appreciation potential if yields fall and bond prices rise.
She said fixed-income investments might also gain value in an equity-market shock, unlike cash, but added that bonds are not risk-free and bond prices can be hurt if interest rates continue to rise.
Benz also said bond investors face inflation risk similar to cash, because higher prices reduce the purchasing power of interest earned.
For how to divide assets, Benz pointed to Morningstar’s Role in Portfolio framework, saying cash is typically appropriate for spending horizons of two years or less or when ongoing liquidity is needed, including for retirees who may earmark one to two years of anticipated spending in cash.
She said bonds fit spending horizons of two to 10 years, while equities are a reasonable bet for 10 years or beyond, depending on both time horizon and an investor’s ability to handle portfolio fluctuations.
Benz said retirees who are willing to make course corrections in their spending may be better suited to heavier allocations to stocks, and that retirees with sizable portfolios and modest spending can often maintain more in equities than those drawing more heavily from smaller portfolios.
She added that more equity-heavy mixes tend to leave higher residual balances, which can help if an investor’s goal is to have leftovers at the end of retirement.
Benz’s guidance was provided by Morningstar personal finance and retirement planning.
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