Managing cash and investments always tiptoes around risk versus reward. The more risk you are willing to take, the higher the expected return.
In the past, risk averse individuals & corporations could always count on the safety of fixed income to pay them a reasonable rate of return. These days the interest payments are not what they used to be, and will likely continue to go even lower. We believe this distortion may be producing odd actions in other markets.
One school of thought says that because interest rates are so low, one needs to incur more risk for cash earmarked for “safety”. The thinking goes like this:
A risk free US 10-year bond is paying you 0.67% yearly if you hold it to maturity. The S&P 500, on the other hand, is currently paying 1.71% in dividends with the potential of price appreciation.
What do you do?
Some believe the easy mental math is to take your more “conservative” dollars and now put them in the S&P 500. You will get paid 2x that you would in the 10-year treasury bond investment AND you get equity exposure to heavyweights like Apple, Microsoft, Amazon. Tough to find someone who believes they go out of business.
The above thinking is what some attribute to the rally from the COVID March lows to the recent new all time high. The assumptions also believe the equity rally can continue until the Federal Reserve adjusts rates higher.
We try not to discount any theory until proven otherwise. Still, it is impossible for us as asset managers who focus on safety and security to say - YOLO!
As a responsible steward of capital one must always remember that one invests in specific assets for a specific purpose. Here are the key assets when one is focussed on Capital Preservation:
T-bills and government bonds are for next day liquidity and unparalleled safety.
Bank Certificates of deposit are for safety and slight yield enhancement.
High grade corporate bonds for even greater yield enhancement, while having a primary focus on capital preservation.
An asset manager is only as good as the toolbox they have. Throwing away the hammer to use a wrench to put in a nail will only get you so far. That is why the safety and predictable nature of fixed income is so wonderful. You may be getting paid less currently but you know what you get and stretching for yield in equities and risky fixed income securities can backfire and cause portfolio ruin.
There are no free lunches in the markets, so please be skeptical when you hear people talking about TINA.