I have had a few people starting to ask me this question recently, so I thought I’d put something together that will help answer this for everyone. It’s a totally fair question and I understand why people are asking!
We are currently in a high interest rate, and highly inflationary environment, with interest rates on term deposits just creeping over 6%. We haven’t seen returns from investment portfolios at this level for a few years now (although equity returns this year have been very good so far), so it does look attractive.
This is why I’d caution against long term investors switching into term deposits:
You could miss out on the recovery
The impact of being out of the market for a short time can be huge, as shown by this hypothetical investment in the S&P/ASX 300 Index, a broad Australian stock market benchmark.
- A hypothetical $1,000 investment made in 2000 turns into $5,643 for the 23-year period ending 30 June 2023.
- Miss the S&P/ASX 300’s best week, and the value shrinks to $4,951. Miss the best three months, and the total return falls to $4,281.
- There’s no proven way to time the market— targeting the best days or moving into cash to avoid the worst.
Staying invested and focused on the long term helps to ensure that you’re in position to capture what the market has to offer. If you come out of the markets and into cash, you’ll have to go back in at some point, and that would probably end up being when you felt more confident about the market, which would likely be after it had already recovered. This would mean you’d missed the gain you otherwise would have received by staying put.
Markets don’t wait for official announcements
Some people may worry about the stock market going down after a recession is officially announced. But history shows that markets incorporate expectations ahead of the news.
- The global financial crisis offers a lesson in the forward-looking nature of the stock market. The US recession spanned from December 2007 to May 2009 (shaded area).
- But the official “in recession” announcement came in December 2008—a year after the recession had started. By then, stock prices had already dropped more than 40%.
- Although the recession ended in May 2009, the announcement came 16 months later, by which time US stocks had rebounded.
Investors who look beyond after-the-fact headlines about markets and the economy and stick to a plan may be better positioned for long-term success. Whilst there’s more talk of another recession, the possibility of it happening, has already been priced into the markets, they have already factored that in, so if it does happen, it’s not going to have a big impact on portfolios.
Market behaviour and the weather
Have a look at this great video which explains markets in terms of weather (short term) and climate (long term).
I’ve split these up, but really, they all say the same thing!
Whilst cash may be offering a better short-term return (which is guaranteed and therefore attractive), long term, we know that it won’t do better than a diversified portfolio. Interest rates will come down eventually, and by the time that happens, and you consider re-entering the markets, you may have lost out on a lot of potential returns.
Cash is great for liquidity, emergency funds, and for holding money you know you’ll need to spend over the next few years. As a place to hold money long term for your retirement though, it’s unlikely to keep pace with inflation, or portfolio returns.
To most of us, 3 years seems like a long time, but when it comes to markets and portfolios, it’s very short term. Unless your plans, goals or risk appetite has changed, then the best thing to do is to stick to the plan, keep reviewing things, and don’t panic (and ask your financial adviser if you have any questions).
You may also want to read our previous article A Consideration of Term Deposits versus Investing – BWT Financial.
The article is for information only and should not be considered personalised advice. Please speak to a financial adviser for specific advice before making any changes to your investments.
Past performance is no guarantee of future results. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment.
In US dollars. S&P data © 2023 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
Start and end dates of US recessions, along with announcement dates, are from the National Bureau of Economic Research (NBER). nber.org/research/data/us-business-cycle-expansions-and-contractions and nber.org/research/business-cycle-dating/business-cycle-dating-committee-announcements
Stock price decline of more than 40% from December 2007–December 2008 is based on the S&P 500 Index’s price difference between the actual start of the recession in December 2007 and the official “in recession” announcement 12 months later.