Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Both stocks and bonds have regained their footing in 2023 after a tough 2022. But there are several pitfalls investors should be aware of and avoid in today’s market. Morningstar’s director of personal finance and retirement planning Christine Benz is here to discuss them with us.
Nice to see you, Christine.
Christine Benz: Hi, Susan. Always great to see you.
Dziubinski: Cash yields have gotten very attractive. And you think that one potential pitfall investors might fall into is really being complacent about their safe holdings. What do you mean by that?
Benz: We had such a long period where it was very hard to get excited about the difference between earning 0.10% and 0.25%. And so, we’re finally in an era where cash is yielding something. So, don’t just sit with that bank savings account that is paying you barely nothing when if you shop it around a little bit, you can pick up a substantively higher yield. The key thing as you’re thinking about your short-term investments is just kind of thinking about the interplay between yield, your need for liquidity—so is this something that you’re paying bills out of? You’re needing to have ongoing cash flows out of? So, look at liquidity and also look at guarantees. So, is it FDIC insured? Is it not FDIC insured?
And for most of us, we might have a little range of cash holdings that we might have different goals for different pools of money. But consider your own situation and do that due diligence to shop around, look at CDs, look at high-yield savings accounts, look at the whole gamut, but don’t settle for that brokerage sweep account, which often has just an extremely low yield for the convenience of having that money sit alongside your long-term assets.
How to Rightsize Your Cash Holdings
Dziubinski: Related to cash, another potential trouble spot would be people saying, “Hey, cash is really yielding a lot today,” and maybe putting perhaps too much in cash today. How can investors really know how to rightsize their cash holdings?
Benz: It’s a really good question, and I do think that temptation is looming large when we look at the fund flow data. Investors are really buying the cash-type investments. Money market mutual funds have been getting good flows. But I think you do want to be careful about overallocating because the yields that we see today may prove ephemeral, and they can change on a dime, where unless you’re in a CD where you have your money locked up for a certain period of time, if you’re in some sort of a high-yield savings account, the payout can change very, very quickly. So, it may not be here to stay, which is the reason why I think investors should really think about their own situation, think about their own portfolio spending needs. Older adults I think could think about having maybe one to two years’ worth of portfolio withdrawals in cash. Younger people who are still working would want to think about having those liquid reserves amounting anywhere from three to six months to up to a year. But you probably don’t want to overallocate to the safe investments because over time you will be able to pick up a higher yield with investments that have some interest-rate sensitivity and some risk attached to them.
Dziubinski: Let’s pivot and talk about bonds now. What are the areas of caution here or the pitfalls that investors might be prone to in today’s market?
Benz: Right. Kind of a corollary to what we were just talking about, about overallocating to cash investments, I think there may be some nervousness after 2022 and how bad it was for the bond market for investors just to keep it super safe, keep it short term. And indeed, yields are really competitive with short-term bonds versus intermediate-term bonds. It might look like it’s kind of a sucker’s bet to be delving into intermediate-term or longer-term bonds. I think the key thing you want to keep in mind is just that inflation is a factor. And as a bond investor, even though you do pick up some interest-rate-related volatility in the intermediate-term and longer-term bonds, you do have a little bit more insulation against inflation. So, I’d be careful about overallocating to short-term bonds. I think you’d want to let your portfolio spending needs dictate how much you have allocated to short- and intermediate-term bonds. I’m not sure that investors need to have a dedicated allocation to long-term bonds. But I would kind of apportion my portfolio across short- and intermediate-term bonds.
The other potential pitfall in the fixed-income space is looking at the fact that higher-yielding, lower-quality bonds have actually really outperformed high-quality bonds. And so, I think there’s some risk for investors at this point by looking at those higher-risk, junkier bond types. Higher-quality bonds will be your friend in a recessionary environment. So, you might have a little dash of the low-quality stuff, whether it’s a dedicated junk-bond fund or a multisector fund. But for the core of a fixed-income portfolio, I like the idea of sticking with high-quality, short- and intermediate-term bonds.
Dziubinski: And then lastly, Christine, what about on the equity side? What are some of the stock-related pitfalls today?
Benz: I think the big one is recency bias, where at least for the year to date, we’ve had such strong outperformance from growth stocks again, and that was after even we’re setting aside 2022, but prior to 2022, such stocks had had such a tremendous run. I think that there’s a risk for investors today in terms of just letting those winning companies ride. Valuations are high there today, or certainly higher. So, I think you’re just looking for balance within your equity portfolio. You’re looking for value. You’re looking for blend and growth. You’re also looking at the market capitalization range as well, where we’ve had a period where large-company and midsize stocks have outperformed small-company stocks. Just make sure if you have a dedicated small-cap allocation that you’re topping that up and that you’re doing the same with non-U.S. Non-U.S. stocks have been very easy to dismiss. Performance certainly hasn’t been great over the past decade, notwithstanding somewhat decent returns or relative returns in 2022. But I think investors with long time horizons should top up their non-U.S. holdings.
Dziubinski: Well, Christine, thank you for your time today and for your guidance on helping us avoid some of these pitfalls in today’s market. We appreciate it.
Benz: Thank you so much, Susan.
Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.
Watch “What Higher Yields Mean for Retired ‘Bucket’ Investors” for more from Christine Benz.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.