Recent periods of high inflation have led to an increase in interest rates to levels not seen in well over a decade. During times like these, it’s important to continue to stay diligent and avoid leaving money on the sidelines earning low returns that are outpaced by inflation and losing purchasing power.

With interest rates continuing to rise, investors with excess cash should be taking advantage of opportunities that will allow them to maximize their returns without compromising their principal. Individuals will often turn to bond funds or certificates of deposit as a priority when attempting to keep excess cash yielding meaningful returns. One main reason is that financial institutions will market and advertise appealing rates. While these are great options for some, one additional option that is often overlooked is the Money Market fund.

Money Market funds are highly liquid open-ended mutual funds that invest in short-term instruments. Designed to prioritize the preservation of capital while generating a reasonable level of income, these funds become even more attractive as they offer higher yields compared to traditional savings accounts or even some certificates of deposit. By investing in Money Market funds, one can safeguard their capital and earn a competitive return on their investment, thus effectively preserving their purchasing power over time. Money Market funds combine the benefits of stability, competitive returns, and perhaps most importantly they provide excellent liquidity.

Unfortunately, as interest rates rose in the past ~12 months, so did average mortgage rates, a fact not lost on prospective home buyers. As such, many of those prospective home buyers may be waiting to commit to purchasing a home until mortgage rates begin to dip. This is an excellent example of someone that may have a large cash reserve built up from years of saving for a house, that doesn’t want to see their hard-earned money lose purchasing power to inflation but also does not want to expose their savings to the volatility of the stock market. A fixed-income strategy would be very beneficial in this instance and provide the liquidity to access their money when the time comes. This is just one specific example of a fixed-income strategy.

While we certainly cannot discount the safety and advantages offered with a high-yield savings account, or certificate of deposit, Money Market funds such as the Charles Schwab Advantage Money Fund (SWVXX) offers extremely high liquidity while providing an annualized yield of 4.90%. If liquidity is not a high priority, certain CD’s are offering returns in excess of 5.0%.

The Bureau Of Labor Statistics recently reported the 12-month percentage change, Consumer Price Index (CPI), for All Items is 4.9%. While inflation has pulled back some in recent months, it remains an eroding factor in one’s portfolio but fortunately can be mitigated with the right investment strategy.

Fixed-income investments should always be matched to one’s goals. For the long-term investor, a Money Market fund, or CD is not our recommended investment strategy. However, the individual with excess cash set aside for future known expenses may find value in the appropriate strategy and simultaneously maintain purchasing power during a period of high inflation.

Please reach out to your financial advisor if you would like to further discuss fixed-income investment strategies and how they may or may not align with your goals.

Emotional decision-making fueled by fear or greed can cloud our judgment and lead to irrational investment choices. Reacting to short-term market fluctuations or making impulsive trades based on attention-seeking headlines often leads to poor investment performance. By staying in your seat and focusing on your long-term investment strategy, you can mitigate the influence of emotions.

A disciplined investment strategy is designed to withstand market fluctuations and align with your long-term goals. Deviating from your strategy based on short-term market movements and the constant barrage of headlines can disrupt your financial plan and hinder your progress toward achieving your financial objectives.

2023 has been a year filled with recurring pessimistic headlines, tempting investors to revisit their investment strategy and take money out of the market. The Philadelphia Federal Reserve’s survey-based Business Outlook suggests some manufacturers have a very pessimistic expectation of the economy. The index is more negative than at any time since the onset of the Covid pandemic and on par with the Global Financial Crisis in 2008. In general, negative spikes in this index have closely aligned with economic downturns. But investors shouldn’t let this ominous sign deter them from stocks.

Since the index’s start in May 1968, the outlook was negative in 165 out of 648 months. The return of the S&P 500 Index over the next 12 months was positive for 76% of these 165 observations. To put that in perspective, the frequency of positive S&P 500 returns over any 12-month span during the period was 78%. And the average magnitude of the return following negative months, 13.4%, was higher than the unconditional average of 11.5%. Just another reminder that markets price in changes in economic states before they come to fruition.

The below chart from JPMorgan Chase tracks the Consumer Sentiment Index at its peaks and troughs and compares how the S&P 500 performed in the 12 months following. On 8 separate occasions since 1971, the Consumer Sentiment Index has been recorded as in a trough, the average S&P 500 index return for the 12 months following that trough was +24.9%. Comparatively, on 9 separate occasions when investor confidence was high and the Consumer Sentiment Index was documented as a peak, the average S&P 500 index return for the 12 months following that peak was just +3.5%.

Historically, disciplined investors who resisted the urge to react to pessimistic headlines have allowed their investments time to capitalize on market recovery and minimize transaction costs and taxes. Remember, successful investing requires patience, discipline, and a focus on the long term.

Stocks

Large cap stocks, traded in both international and domestic markets, were up in April; emerging market stocks and stocks of small companies, on the other hand, were down. Year-to-date stocks produce positive returns that range from 1% in small cap stocks to almost 12% for developed international markets. Year-to-date stocks have performed reasonably well with a globally diversified stock portfolio, earning 4%.

Bonds

Since the beginning of the year bond yields were up at the short end, but down across maturities beyond 90 days, resulting in positive bond returns (bond prices move inversely with yields). The pattern of yields across various maturities peaks at three-months and falls off steadily before beginning to move up at about ten years. This shape is consistent with expected lower interest rates, which might be explained by the Fed “taking its foot off the gas,” lower expected inflation, or an expected economic slowdown – take your pick. The spread between nominal and inflation-adjusted five-year yields, a reasonably good indication of expected inflation over that period, stayed at about 2.5%.

Uncertainty

The trajectory of inflation, the path of interest rates, expectations for a “soft landing,” the banking system and a looming debt ceiling are some of the sources of uncertainty today. While we can be concerned about what inflation has been, current numbers tell an improving story – the Consumer Price Index (CPI) was flat for the month and under 1% year-to-date. The Fed seems to be committed to keeping interest rates high. However, keeping them there too long and triggering a recession is a worry. While there could be surprises ahead, markets seem to be taking today’s unknowns in stride. We’ll see.

The Wonders of Compound Interest

Einstein referred to compound interest as the eighth wonder of the world! He went on to say: “he who understands it – earns it, he who doesn’t – pays it.” To profit from compound interest investors must establish and maintain commitments to risky markets through thick and thin. It is especially important to avoid the common urge to move into the asset class with the best recent results. While diversification means always looking back with regret from commitments to some markets, the fruits of compound interest come from enduring this short-term regret and looking ahead.

The wonder of compound interest lies in its ability to turn small amounts into significant sums over time (playing golf for $1.00 that doubles every hole means playing the 18th hole for more $260,000!). It is the process of earning interest on both the principal amount and reinvested interest that accumulate over time. It means that the longer the portfolio is left untouched, the more it will grow due to this compounding. It is a powerful tool to leverage time to achieve investment goals and weather market volatility.

Investors seeking to build wealth know they must endure risk to achieve growth. Maintaining a diversified portfolio throughout the inevitable market ups and downs is the best way to navigate an uncertain path to growth and realize the wonder of compound interest.