By Callie Cox for eToro
Money, especially in the form of cold, hard cash, can stir up a variety of emotions within us. The crumpled notes in your hand, the distinct scent of currency, and the sheer might of a stack of hundred-dollar bills under your control; it all evokes the ultimate sense of security.
However, in recent times, individuals have been opting for the perceived security of cash over investing in stocks and cryptocurrencies. Money market funds have seen an increase of nearly $1 trillion this year, fueled by people seeking a decent — and relatively risk-free — return. The allure of cash seems to be obvious when interest rates are high and the economy feels unstable. Yet, this obsession with cash may harbor a significant blind spot.
Appeal of Cash Amidst Market Movement
The S&P 500 has seen a 17% surge this year. Bitcoin has more than doubled in value. Even gold has recorded a respectable 9% return. Despite these impressive performances, thanks to 5% interest rates, cash appears to be the hottest investment on Wall Street. It’s almost comical how individuals who had ventured into meme stocks and speculative tech are now earnestly discussing CDs, I-bonds, and Treasuries.
Given the recent hike of 11 times by the Federal Reserve since March, short-term rates are at their highest in 17 years. Coupled with the perpetual concern of a looming recession on Wall Street, it’s understandable why cash is capturing everyone’s attention.
The Deceptive Safety of Cash
It’s not just the allure of high rates and safety that entices people into cash. With Americans spending at an unprecedented rate, it’s reasonable to assume that some are building up their reserves for short-term financial goals such as purchasing a house or a car. Moreover, the aging Baby Boomers could also be stashing cash for retirement.
However, overlooking the appealing prospect of a risk-free 5% return when compared to the performance of a few popular stocks might be a grave mistake. Despite a considerable number of individuals stockpiling cash, they seem to be turning a blind eye to a significant risk.
Unforeseen Consequences of Hoarding Cash
Money market fund assets over time tell the story of cash accumulation when people become increasingly apprehensive about the future or are blindsided by an economic downturn. Conversely, when the clouds clear and the stock market enters a bull phase, cash levels drop while other assets rise.
Interestingly, the reverse has been occurring in the past few years. Cash levels dipped in 2022, even as the S&P 500 and Bitcoin suffered through vicious bear markets. This year, despite the signs pointing towards a bull market in stocks and cryptocurrencies, cash levels have risen.
From an analyst’s perspective, the upward trend in cash levels can be a positive indicator for other markets. Even though people are increasing their cash holdings, there has still been significant investment activity leading to price upticks. This surplus of cash could eventually flow back into stocks and cryptocurrencies, potentially bolstering an even stronger bull market.
The Future of Cash and Its Implications
The lingering question now is what could prompt individuals to move out of cash. The answer could hinge on interest rates and the state of the economy. If people are drawn to cash due to high 5% rates, the influx of funds into the markets could be imminent. On the flip side, if economic uncertainty is the driving factor, cash hoarding may persist regardless of diminishing rate hikes. After all, the specter of a recession still looms large.
Historical data on money market trends since 1950 indicates that people tend to retain cash until around 13 months into a rate-cut cycle. Hence, it’s unlikely to foresee a significant shift away from cash anytime soon. However, psychology may also play a role, as a potential interest rate decrease could trigger a mass exodus from cash. In such an event, the resilience of the economy could also act as a deciding factor.
Key Preparations in Response
Prepare for a shift. While high rates are advantageous for your bank balance, they are transient. It’s crucial to recognize this, especially at present. If the economy decelerates and inflation diminishes, the Federal Reserve could transition from rate hikes to cuts, leading to the disappearance of those coveted 5% rates. If you’re accruing savings for a near-future expenditure, it may be prudent to secure these favorable rates while they are available.
Assess the trade-offs. Prolonged reliance on cash incurs substantial opportunity costs. Over protracted periods, stocks and bonds typically outperform cash, especially when interest rates climb to enticing levels. If you find yourself enveloped in the comforting embrace of cash, it’s crucial to contemplate your long-term strategies. Keeping emergency funds in a savings account is wise, whereas parking investing funds in cash for extended periods is not.
Monetize on the waiting game. If you’re persistently biding your time in cash until the right investment moment arises, it’s essential to ensure you’re gaining from this waiting period. On eToro Options, we offer a 4.9% interest on your uninvested cash with no minimum deposit, considerably surpassing the average rate of money market funds, which stands at a mere 0.61%. Learn more here.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.