Recently, investors were seeing almost a 0% return on cash. Over the past year or two, with the Federal Reserve maintaining high interest rates to combat inflation, users can now easily earn a 5% annual return on cash savings accounts and other low-risk investments.
According to a report from CNBC, an estimated $6 trillion is currently parked in Money Market funds. Industry research has found that young investors are allocating the most funds to cash accounts, despite being the most capable of handling long-term risks.
A recent study by Bank of America found that in the past two years, over half (55%) of young wealthy investors aged 21 to 43 have increased their cash holdings, compared to 46% for those aged 44 and above.
While Bank of America’s focus is on investors with at least $3 million available for investment, trading and investment platform eToro discovered that young investors are twice as likely to increase their cash assets compared to their parents’ generation. The study surveyed 1,000 U.S. retail investors who were part of a larger group of 10,000 retail investors from 13 countries and regions, all holding at least one investment asset.
“There’s not enough attention being paid to the potential issue of young investors being lured by a 5% savings rate to overexpose themselves to cash,” said Callie Cox, Chief Market Strategist at Ritholtz Wealth Management in an interview with CNBC.
In the long run, a 5% return may be lower than the potential returns investors could achieve in the stock market. A more aggressive investment portfolio could yield an average annual return of 7%, with some years performing even better and others slightly lower.
On Monday (July 1), Thomas Lee, Managing Partner of Fundstrat Global Advisors, stated on CNBC’s “Squawk Box” program that the S&P 500 index could climb to 5,800 points by the end of this year, resulting in a total annual return of over 20%.
Lee noted that the index had a 24% return in 2023, bringing the total return over two years to around 50%. He explained that for cash investors missing out on these high returns, it could be “painful,” as it would take them 10 years to achieve similar gains.
“I think for those who say ‘Oh, I’m happy with the 5% return on $6 trillion in cash,’ this year-end will be a final reckoning, but in reality, unless the economy slips into a recession, expansion might continue for a while,” Lee said.
However, not all financial experts share the same optimism. BCA Research predicts that if a recession hits, the S&P 500 index could drop over 30% later this year.
Of course, financial experts advise all investors to keep some cash on hand. Financial advisors typically recommend keeping three to six months’ worth of expenses in cash for emergencies.
Research shows that many Americans fall short of this goal. According to a recent survey by financial services company Empower, the median emergency savings account balance for Americans is only $500.
In a study by Bankrate, it was found that among Americans with cash savings, 67% still earn less than a 4% annual return.
Cox suggests that for money needed in one to two years, or even three to five years, keeping enough cash to ensure availability when needed makes sense. “But beyond five years, I would seriously consider putting that money into stocks or other higher-risk assets,” Cox said.
Fear may be one reason why investors are currently leaning towards holding onto cash.
Cox points out that while the stock market can go up indefinitely or drop by 50%, these are extreme scenarios. “If you’re just holding cash, you could be waiting a long time for a pullback,” Cox said. She added that the biggest risk investors face now is missing the next upswing after this rally.
If the Federal Reserve starts cutting rates after inflation recedes, the cash savings environment could soon change, potentially reducing the 5% cash return rate. Mark Hamrick, Senior Economic Analyst at Bankrate, mentioned that depositors can lock in today’s rates with a five-year CD, but they should be aware that early withdrawal penalties may apply if they need the money within five years.
“In the near term, rates on CDs, high-yield savings accounts, and money market accounts are likely to remain elevated,” Hamrick said. “Rates may decline, but not collapse like a stone but fall more like a feather.”
(Note: This article is for general information purposes only and does not constitute any recommendations. The media outlet does not offer investment, tax, legal, financial planning, real estate planning, or other personal finance advice. For specific investment matters, please consult with your financial advisor. The media outlet does not assume any investment responsibility.)