Heading into 2022, both the stock market and bond market were trading at lofty valuations. It’s hard to put your hard-earned cash on the line when investments are so expensive, and many investors may be wondering if stashing cash somewhere might be a good alternative.
The first week of 2022 wasn’t kind to investors, and it may have scared some of them to build up more cash reserves. But cash may not be the best place to put your money in 2022.
The inflation headwind
It’s hard not to talk about the value of cash these days without talking about inflation. The consumer price index — a measure of the average change in the prices paid by consumers — increased 6.8% in November. It’s also showing strong month-over-month growth, up 0.8% from October. So investors shouldn’t expect inflation rates to come back to pre-pandemic levels anytime soon.
Meanwhile, holding cash in a savings account is unlikely to produce any nominal return. The average savings account offers 0.06% interest. That’s because the overnight rate from the Federal Reserve remains low. While the Fed may be increasing the rate in 2022, investors shouldn’t expect a meaningful bump in savings-account interest rates because they remained low during the Fed’s last series of rate increases at the end of the last decade.
In other words, you’re practically guaranteeing a loss of value if you hold cash in 2022. The question is whether that guaranteed loss is better than other investment options.
Is it worth the risk?
Market valuations are certainly very high. The Cyclically Adjusted P/E (CAPE) ratio — a historical measure of market valuations based on the price-to-earnings ratio — hasn’t been this high since the dot-com bubble. And it was never this high before that.
But you can’t look at stock valuations in a vacuum. Treasury bonds are also yielding near historic lows. That means the risk-free rate of return is very low, and investors should, therefore, be willing to accept lower returns from stocks and thus, higher stock prices.
At the very least, investors should have lower expected returns for stocks and bonds on a long-term basis. That could come from slow-and-steady growth or an imminent crash and return to historical growth rates thereafter. It’s impossible to say with any certainty.
If you’re planning to invest for the long run, you’ll in all likelihood end up with a more valuable portfolio by investing in stocks in 2022 than holding cash over the next decade-plus. Still, you may feel uneasy investing your money knowing …….