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Why not hold cash instead of bonds?

Holding cash as a long-term investment and not just a source of immediate liquidity can be detrimental to long-term purchasing power.
Inflation erodes purchasing power over time chart

With yields currently exceptionally low across much of the fixed income market and the expectations that rates will rise at some point, investors may question the wisdom of investing in bonds rather than simply holding cash instead. Why take on the additional duration risk of longer-term bonds when the incremental yield is low?

However, cash isn’t an ideal substitute for bonds. As shown above, real (inflation-adjusted) yields on cash investments (as approximated by the one-month U.S. Treasury yield) have typically been negative, indicating that returns on cash haven’t kept pace with inflation. The result? Holding more cash in the portfolio than is needed for short-term liquidity needs can erode the portfolio’s purchasing power over time.

Certainly, the income generated by high-quality bonds today is limited, but still exceeds cash yields. Over a given period, bond values may decline as interest rates rise, but the yield-to-maturity and value at maturity is known, as long as the issuer doesn’t default — a very improbable outcome for high-quality bonds.

The bottom line? Cash might seem safe, but in inflation-adjusted terms, is likely to lose value over time. Maintaining a reserve to cover near-term expenses is advisable; replacing a strategic bond allocation with cash isn’t.  

Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.

Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources believed to be reliable. However, some or all of the information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis nonfactual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.

Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.

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