When markets crashed in early 2020, many investors liquidated holdings to cash. However, during the subsequent market recovery, relatively little cash was put back into the market. Net flows (fund inflows - outflows) to US money market funds were almost $700 billion, a record amount according to Morningstar. Although there were some outflows from money market funds towards the end of the year, total money market assets at the end of 2020 were $4.3 trillion.
Source: Morningstar data for US open-ended and money-market funds excluding fund of funds as of 12/31/20
Cash can be a useful tool in times of uncertainty and volatility, which was common in 2020. But the safety net of cash does come at a cost. With interest rates at record lows, cash is returning almost nothing. As a result, investors pay a significant opportunity cost for staying out of the market for long periods of time. The low return potential for cash comes at a time when many analysts expect strong economic and earnings growth in 2021.
A common concern we see regarding investing excess cash into equity markets is high valuations. However, valuation measures are not necessarily good predictors of future returns over a short time period. Here, a chart from JP Morgan Asset Management shows the extremely low correlation between the forward P/E and 1 year returns for the S&P 500.
Source: FactSet, Standard & Poor’s, Thomson Reuters, J.P. Morgan Asset Management.
High valuations can mean lower annual returns over a longer time period, but they do not necessarily end in disaster. As you can see in the chart below, the S&P 500 has often been near all time highs. Large drawdowns are more common near economic recessions (gray bars) as opposed to just high valuations.
So if you have excess cash to invest, how do you decide when to enter the market? The best way to move forward is by developing a clearly defined long-term plan. By establishing goals, investors can proceed with confidence even when there is uncertainty in the market. A professionally managed portfolio can help ensure that investor goals and time horizons are properly aligned with risk and investment assets. Some common areas to consider:
- Is your investment time horizon short-term or long-term?
- Do your assets need to be readily available, or can you tolerate some illiquidity?
- Are the assets in a taxable or tax-deferred account?
- How much risk can you tolerate without being susceptible to making changes based on emotion?
To learn more about how to invest based on your financial goals, schedule a complimentary meeting with us today.