Written by Tom Stanley, Investment Adviser, August 2023
Dennis Van Tine/ABACAPR/ESS.COM via The Canadian Press
With term deposit and cash on-call rates up around 6%, cash is interesting.
In this note from June, I showed you how New Zealand investors can keep more of your returns (and pay less tax).
This month, I want to shine a light on how you can get term deposit like returns from cash, without being locked in… and why not being ‘locked-in’ matters if you have an investment timeframe greater than 3 years.
Summary (Too Long Didn’t Read)
- On the 4th of July 2023 Joey ‘Jaws’ Chestnut won Nathan’s Hot Dog Eating Contest for the 16th time.
- As a ‘Rhythm eater’, Chestnut trains his breathing, muscles, and tactics around a tempo of ‘two hotdogs’, ‘two buns’, ‘two hotdogs’, ‘two buns’.
- Breaking the competition into these ‘smaller bites’ has seen Chestnut set a record of 76 hot dogs in 10 minutes (in 2023 he only ate 62).
- With elevated interest rates, investing new money in a similar mindset is wise. Term deposits often have $10k-$50k minimums and break fees, but if you hold cash in a cash fund, you can take even smaller more regular bites.
- Elevated cash rates will not last – so, when do you roll out of cash?
- Having a ‘Rhythm’ and averaging-into investments with ‘smaller bites’ during times of uncertainty can help with managing emotion, while balancing risk and regret – How small? How often?
Let’s dig in…
Joey ‘Jaws’ Chestnut
There are competitive eaters, and then there is Joey Chestnut. He is most famous for his success in Nathan’s Hot Dog Eating Contest, but a quick glance at his Wikipedia bio shows he is the best professional eater of all time.
His list of accomplishments is dizzyingly long. He owns the world record for most hot dogs eaten in 10 minutes (76), as well as 54 other world records for eating just about any food you could imagine.
You might think of competitive eating as mainly a test of stomach capacity, but that’s only part of the package needed for success. If you watched the YouTube link above, you would have seen that chewing and swallowing all that food takes a toll on the jaw and throat muscles. As Chestnut told Delish, his throat usually becomes tired around seven minutes into the competition, forcing him to shimmy his entire body so the hot dogs slide down his neck.
The ESPN documentary “The Good, The Bad, The Hungry,” profiles Chestnut and digs into his training techniques and how he combats fatigue. The Nathan’s champ works out his jaws and neck with a self-designed training regimen. In it, he chews a small rubber ball for jaw strength and does head lifts while carrying a weight in his teeth to exercise his neck. To strengthen his throat, he gulps air while doing small crunches on a weight bench. This regimen improves his bite strength and allows him to swallow pounds of food before becoming tired.
Nathan’s, the hot dog maker, estimates that 70 hot dogs is around 20,000 calories – a super human appetite!
Getting through that volume of hotdogs in 10 minutes requires consistency and strategy. In competition, Chestnut is known as a ‘rhythm eater—consuming two hot dogs, two buns, two hot dogs, two buns over and over.
What does competitive eating have to do with the world of investments? Nothing directly, but after reading about Joey’s incredible feat of eating 76 hotdogs (and buns) in 10 minutes, I thought I could draw some interesting parallels to some of the psychological barriers investors are going to have to push through over the coming years.
Cash is Comfy
“In investing, what is comfortable is rarely profitable” Robert Arnott
It is human nature to like the safety and certainty associated with hoarding cash, especially when everything feels so uncertain. But the below chart shows that over the longer-term holding cash has not panned out well – I have previously drawn readers attention to the shrinking size of a 50-cent mixture at their local dairy to reflect the waning purchasing power of a dollar and poor returns on cash over the long-term.
Despite intuitively understanding loss of purchasing power over time, our desire for safety and certainty means we still feel comfortable hoarding cash, and the fact that cash returns are up over 6% right now makes holding cash even more attractive. But as the above chart shows, this ‘high’ return for taking ‘no risk’ is a recent phenomenon that is unlikely to last.
The problem? Like trying to eat 76 hotdogs (and buns) in 10 minutes, it can be difficult to know where to start when it comes to investing for the longer-term. Embracing uncertainty and investing into assets that will better buffer the impacts of inflation is not easy, especially if you are investing ‘new’ money and risk averse.
Getting started is tough – How you hold and invest your cash may be holding you back – on taking smaller bites.
Most Kiwis I meet with are familiar with term deposits, cheque accounts, and savings accounts.
Most Kiwis also know that they will get paid much better interest if they ‘lock up’ their cash in a term deposit rather than hold it in a savings account. But term deposits often have minimums of $10k to $100k which may feel like too much to roll into uncertain markets when the money rolls off term.
Most Kiwis are not familiar with Cash Funds that I discussed in this note in May. With a Cash Fund, you can take similar risk, get term deposit like returns (or better after tax), and not be subject to a lock-up period. In other words, if you are looking to deploy money right now, a cash fund is the place to be.
While you will receive a floating interest rate in a Cash Fund, minimum investment size is generally much smaller than term deposits, meaning you have much greater flexibility – if you want to invest cash, but are risk averse or worried about the state of the world – Holding cash in a Cash Fund allows you take smaller bites (average in).
This paper from Vanguard highlights that in most cases investing a lump sum of cash tends to outperform averaging into an investment in smaller increments. However, when returns on cash are high, the gap between averaging in and lump sum narrows – The punchline of their research is ‘if you are investing for the long-term, both averaging in and lump sum contributions win out versus just holding cash’.
So, imagine receiving a windfall due to an inheritance, bonus payment, sale of a property, or sale of a small business. Having seen the above charts, how would you invest the cash? Would you immediately invest all of it as a lump sum? Or would you make a series of investments over time to avoid the risk of investing the entire amount right before a market downturn?
Both can be reasonable answers – it depends on your situation, but the key actually lies in clearing the hurdle that is ‘getting started’.
For example, walk into your garage and look around. What do you see? In my garage I have a hand-me-down chainsaw I have been meaning to fix, and a lawn mower that needs an oil change… I know what I have to do, but weekends roll past, and I don’t do anything.
As humans we love to put off decisions for the future, often to our own detriment.
Here’s three phrases we hear often when it comes to investment:
“I want to invest, but markets have run up a lot, so I’m going to just wait until they pull back a bit before I buy.”
“I want to invest, but the economy has struggled recently, so I’m going to just wait until it recovers before I buy.”
“These markets seem volatile, and I want to see how XYZ geopolitical event plays out, so I’m going to just wait until things are more certain before I buy.”
In all three cases, the investor is likely just delaying a decision so they don’t have to decide, so they don’t have to act. If you take action then you could be WRONG, and no one likes to be wrong. It’s uncomfortable. And if the decision was part of a debate with a spouse or neighbour, not only could you be wrong, but you will then face the ultimate worst phrase: “I told you so.” That’s like being wrong twice.
It’s easier to just put it off until tomorrow. Then it will be easier. (hint: It won’t.)
Intuitively we all know how to get past the mental hurdles we create. The secret? Start small. If you hold cash in a cash fund, you can take smaller bites into investments managing both risk and regret – you don’t have to be right or wrong.
How big is a small bite? When do you bite? And how regularly? Joey Chestnut’s Rhythm is ‘two dogs’, ‘two buns’, ‘two dogs’, ‘two buns’ – What is yours?
On Finding Your Rhythm…
If your investment timeframe is greater than 3 years, there are likely better places to invest than just holding cash or term deposits.
One simple way to average in (if you are of the DIY sort) is to simply break your funds into equal parts and deploy over the regular timeframe (i.e. weekly, fortnightly, or monthly). The above-mentioned Vanguard paper points to a 3-month period of averaging in being a balance of opportunity cost (regret) and risk, however you can use longer timeframes if it makes you more comfortable.
At Amicus, if we are working with a client to deploy a large lump sum of cash, we first consider the timeline and experience of the client – if the investment timeline is greater than 30 years and the client is ‘adventurous’ we would typically look to deploy funds in into their personalised investment strategy in a lump sum approach. If the investor is risk averse, or the timeframe is shorter, we apply a little more nuance and look at averaging in:
As outlined above, with cash rates of return equivalent or better than term deposits, there is no need to term up cash – meaning we can be in cash funds and nimble.
Based on current market valuations, we generally split a clients funds into 12 pieces (held in a cash fund) and look to deploy month-to-month – While our default is to put 1/12th of the funds to work each month, we consider valuations and sentiment (per my note last month) and look to speed up, slow down, or even pause if necessary. At a high level we take the following action:
- If valuations are above 20-year averages and sentiment is neutral – Spread new $ in 1/12th deploying equally over 12 months – CURRENT SITUATION
- If sentiment is greedy + overbought = Pause and reassess in following month (most of 2023 year to date)
- If sentiment is fearful + oversold = Deploy at 2x planned pace
- If valuations are below 20-year averages – Spread new $ in 1/3rds deploying equally over 3 months.
- If sentiment is greedy + overbought = Deploy at ½ planned pace.
- If sentiment is fearful + oversold = deploy full size.
While this approach is far from perfect, it allows us to proceed with caution when assets are expensive, while trying to be greedy when others are fearful.
I won’t dig any deeper into the technicalities of sentiment, valuations or technicals that we observe in this note, but hopefully this offers some insights around how to remain nimble and how you might approach investing new money in volatile times where sitting in cash is nice and comfy.
P.S. This note is not making a case for holding zero cash as part of your investment or retirement plan. It is also not saying that a cash fund is the best and only way to hold cash. At Amicus we regularly use the defensiveness of cash as a buffer specific to each clients goals and plans and may use a mix of term deposits, cash funds, and on-call accounts – as always the right answer always depends on your goals and plans.
If you want to discuss how you can get the most out of the cash you want to hold or discuss how you might look to deploy new cash into a longer-term investment or retirement strategy, please feel free to reach out.
We are here to help.
While this note discusses concepts and ideas the Amicus team use in providing financial advice, it is not personalised advice – if you would like to discuss your circumstances, please feel free to book a call with one of our advisors via the booking links below.