John Nersesian: 5% Cash Is Great. Don't Fall in Love With It.

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This podcast was recorded on November 30th, 2023.

Hello and welcome to Barron's The Way Forward. I'm Greg Bartolus, and my guest today is John Nersesian, Head of Advisor Education at PIMCO. Today, he will discuss how advisors can overcome objections by clients to moving out of cash. John, welcome to the podcast.

Thanks so much, Greg. It's a pleasure to be with you today.

Well, thanks so much for joining us. Now, before we delve into the topic at hand, you have an impressive impressive background that touches the worlds of wealth management and education, which is kind of ideal for your role in this topic. Tell me briefly about your background, then let's get into the topic.

Yeah, sounds great. I don't know if it's impressive or just lengthy, which means that I'm getting older. It can be both. Yes, exactly. I started my career at Merrill many years ago as an advisor. And so I really enjoyed that opportunity to work with families, to help them make better decisions, to help them achieve better outcomes, not just for the financial benefit that they derive, seeing a larger balance on their monthly statement, but really to helping them fulfill their purpose, right? Money has a purpose, and there's a reason that we work hard and save. It's to accomplish something in this world for ourselves or for people that we care about. Beyond that, I also spent some time at Nuveen. I was the managing director of our wealth strategies group. I joined PIMCO about 6 years ago, but maybe the most fun I've had in the industry is as an instructor. I help develop and teach both the CIMA and the CPWA certifications for financial advisors. Those programs are held both at Yale University and the University of Chicago.

And tell me, how did your current role come about? What was the backstory to that?

Yeah, I was kind of retired after Nuveen was sold to a private equity shop about 6 years ago. And my wife decided at the time that I was not ready for retirement. And so the truth of the matter is, is I really wasn't quite ready to step aside. I'm almost embarrassed to admit this to you, Greg. I actually like what I do. It's fun.

How dare you?

Yeah, exactly. A lot of people go to work every day, and unfortunately there are some who don't necessarily have that experience. I really enjoy learning every day, and then in a modest attempt, trying to share that knowledge or that perspective with others where it might provide benefit. That's a very fulfilling experience for me.

Right. And the world and, you know, investing, et cetera, all of this is changing every day. It's an ever-changing landscape. So you're by definition going to be learning every day Greg, you nailed it.

I just came out of a lunch meeting and I was having a conversation with people and we talked about our different careers. And one of the fellows who was with me has been in the same role for about 30 or 40 years. And I've had a couple of changes, a couple of opportunities in my life. I love this idea that we're constantly being presented. We're in an industry that almost requires us to evolve. We're developing new muscles that we didn't know we had before. And in my world, that's a very fulfilling experience.

Yeah, I mean, there's, obvious differences, but that's part of what I like about financial journalism, doing what I do, is that you're creating, but you're learning constantly, you're interacting, and yeah, it's fun. And yeah.

So stop and think about what we do, Greg. What we do, to oversimplify, is we teach, right? Barron's does an unbelievable job through both written and online and the programs that are showing every Friday night. We teach people in an attempt to help them, But in order to be a good teacher, the first thing that we have to be is a good student. And that's the part of the experience that I really enjoy, so.

Let's talk about this seemingly simple topic, but that's really kind of giant because everyone's wrestling with it, right? We have rates now, you can get 5% basically risk-free. What's happening?

Yeah, what's happening is that investors are moving significant piles of money into cash-type instruments, whether it's the $6 trillion in money markets or $15 trillion in total when we include things like CDs and Treasury bills. And listen, there's probably some valid reasons as to why investors are now rediscovering the lure of cash, right? Cash didn't pay us very much if we went back 2 years ago, 4 years ago, but today the returns on cash are pretty attractive. That being said, we want to caution investors as to some of the risks that they may be unaware of that are present when they allocate a significant amount of their capital to cash.

Are advisors recommending that they embrace a little more risk, risk assets more? Are clients saying, look, it's a burden to hand a 5%? Like, maybe what you're telling me makes sense, but in my heart of hearts, this is hard to walk away from.

Yeah. Yeah.

Yeah.

Well, let's start first with some valid reasons as to why one might own cash. It would be inappropriate for me to suggest that, oh, you have too much cash. That's a bad idea. Every circumstance is different. And so there are some valid reasons as to why investors investors should hold cash. Look, if I've got a tuition bill to write next month or next quarter to Lehigh University, I want that money to be available to me or accessible to me. If I've got known liabilities, think about the institutional world, Greg. They use a process known as LDI investing. They anticipate their liabilities. They set aside reserves to meet them. They want to avoid the risk of having to liquidate prematurely and to suffer that potential market decline. That's a very valid reason. Other investors may be keeping significant amounts lots of cash because they want to be a little bit more tactical in their approach. And so first things first, let's not necessarily suggest that investors shouldn't have cash, but let's determine how much they should have and then be a little bit more thoughtful about redeploying excess dollars in ways that can be more productive. That's kind of the message that we're sharing.

Yeah, and going along with how much, I mean, there's also the question of for how long do you intend to tie it up, right? So it might be like, oh, we plan to buy a new car in a year. There's a reason you wanna stockpile cash. Well, that's quite logical, almost even irrespective of high rates. You just wanna have that money on hand. If it's indefinite and you're doing it by your gut and saying, I'll reenter the market when I feel it's safe, there's a high chance that you're gonna come in late and probably engage in some FOMO, get in after everyone's bought and miss a big run or something.

Yeah, Craig, you've hit on a couple of points there, one of which is the emotional part of investing. I'm giving a talk with Richard Thaler shortly, and he's, of course, just a really well-known authority on the subject of behavioral finance, which is, interestingly enough, a big part of what we do. I know that the investing public thinks that financial journalists, financial advisors focus really on money and percentages and tactical investment decisions regarding capital, but we also manage, in addition to client money, we manage people's emotions. And there is that fear and greed aspect that absolutely enter every decision that we make. You know, that being said, I do think that investors need to look at how much cash they're keeping on hand and whether or not they can redeploy some of that for better return opportunities. Somebody once said something that I thought was really intelligent, which is my job as your advisor isn't necessarily to help you earn a great return over the next 3 months. It's to help you develop a great plan that will accomplish your goal over the next 30 decades or 30 years.

Yeah, I mean, so much of it is really calming clients during times of crises and just saying, really talking them off the ledge and just being like, stick to the long-term plan. We've set it. And I know, you know, and they might say, yeah, but you know, when the pandemic hit that we had the fastest bear market in history, the S&P 500 fell 34% in 6 weeks, I believe. And I recall at the time, sitting, looking at my portfolio, and, you know, you're kind of like frozen. You're seeing all the red down arrows, but you still, the mind and the heart, you have to defer to the mind there and say, you know, historically, this is a different kind of risk. We really didn't know. But invariably you have 9/11, you have World War, you know, world wars, et cetera, that the market is a resilient thing. And historically, you know, sitting pat's the best thing. But that's partly where an advisor can certainly add value and just Keep, yeah, keep, address that behavioral component.

I love it. That is a big part of the advisor's value proposition. Not only do I bring to you intelligence and expertise in areas around tax planning and portfolio management and all the other important things that investors face, but I also bring some stability, some perspective, some discipline, if you will, to help you make better decisions and achieve better outcomes than you might on your own. You brought up a concept that I think we need to talk about, which is risk, because I think a lot of investors are overallocated potentially to short-term cash instruments today because they consider it to be risk-free. Now, let's spend a minute or two really defining what risk means in that context, Greg. I get it. Keeping money in money market instruments or short-term Treasury bills, I don't have any principal risk per se, right? I know that I'm going to get my money back when that instrument matures. But there are two other risks that I am taking that the investor may not be aware of. One of which is inflation risk. If I continue to maintain large cash positions, historically speaking, cash has proven to be a very poor hedge against the ravaging impact of inflation. And so that's a risk that investors may be taking that they're not conscious of. But the second risk that I think investors might be taking at this particular moment in time is reinvestment risk. So congratulations, you got a 5-plus percentage rate of return on your short-term cash instrument. The question I'd ask is, what are you going to do 3 months from now or 6 months from now when that instrument matures? And what will your opportunities be when rates have declined? FOMO, you talked about it. I'm going to wait until things feel better or the market conditions change. That's often proven to be an ineffective strategy. There's some really good work that we've done on cash and fixed income And it has been proven that the best returns in fixed income occur not after rates have peaked, but 4 months before they have peaked. And if you're late, if you're waiting until you receive that all-clear siren or notification, chances are you're a little bit behind the curve and your returns will suffer because of that.

Yeah, the bond market in November had, I think, its best month since the '80s, right?

Exactly.

And it's a lot, you know, rates hit 10-year hit near 5% in October. And presumably many of the people who still held out then might've been thinking, "Oh, wait till it hits 6% or whatever." And it's like, yeah.

Yeah. Well, what if it doesn't hit 6%? And by the way, you and I are not here to predict where rates are going. That's, you know, not really where we're gonna be helpful to people. It's the idea of preparing people to make long-term strategic choices that serve their best interests.

Yes. You know, what you talked about that's interesting is that, The burden in hand, you got the 5%, so they see that the benefit part is tangible. The risk, which is in a way the opportunity, the missed opportunity, is however, while it's real, it seems abstract and invisible. They don't quite get it. And this may be a stretch, so forgive me if I'm going on a limb here, but if you think about self-driving cars, one of the argument for them is like, hey, people are fallible, they fall asleep, they drink, you have X number of fatalities. Once you can get the technology up to snuff, these cars will save, self-driving cars will save a ton of lives. Now, let's assume that's all true. The problem is from getting from point A to point B is that every time a self-driving car kills someone, we are acutely aware of it, and it makes headlines, and people say, "See, it kills people, you can't trust it." Well, that, you know, what is happening is real, but it doesn't tell you that on the other side, it may in the aggregate still save a lot, but the way that people die is anathema to what we, you know, want or expect. And so it's a little bit like that defining risk, what you can see and not. I don't know, maybe it's a stretch.

Very selective observation. Yeah, yeah. As we point to those one or two failures, and we hold them out as being representative of the entire universe or set.

Yeah.

I think that's, that's interesting. I want to talk about this premise that investors are hiding in cash and may be reluctant to do something right now because they're concerned that rates may continue to go up. OK, so that's one of the objections that we hear. John, thanks for your thoughts. I'm considering different options, but I think I'm going to stick where I am. I'm going to overweight cash right now because I believe that rates either are or may be going up in the near future. First things first. Number one, it appears to us that rates are probably closer, the Fed is probably closer to the end of their hiking cycle than they are at the beginning. I'm not here to make a call as to whether or not that's a definitive conclusion or not, but that's a pretty obvious position that we might take. But I wanna refer to something known as bond math, okay? Now let's not get too wonky here, but I do wanna understand, if you will, repercussions of what may or may not happen. So let's assume that we start with 5% today, okay? We've got that in cash. Or maybe I can get a 5% return in a longer duration fixed income asset. Okay, remember now, this 5% starting point that I'm afforded today is much better than the 2% starting rate that I had access to literally 24 months ago. So I'm already ahead of the curve because I'm getting a higher coupon or a higher cash flow than I might have. Number 2, let's talk about this possibility of rate changes. If I start at 5%, rates don't move at all, I'm going to get obviously a 5% rate of return. But what happens if interest rates were to move 3% in either direction? A 3 percentage point decline in rates would result in a 16% increase in my portfolio. A 3 percentage point increase in rates would result in only a 5% decline in my portfolio. Bottom line, without getting too granular here, it's the asymmetry of risk and return when I'm starting at a much higher yield. A 1 percentage point movement in rates today, starting at 5%, is a heck of a lot less damaging, Greg, than a 1 percentage point increase in interest rates when I was starting at 1% or 2% a couple of years ago.

That's right. That's right. And someone— the quote, I may be butchering it— is like, yield is destiny. So it's kind of like when you get in, that's really so important. And there's some primacy recency effect. So often we're influenced by that which has recently occurred, and we often extrapolate and assume the recent past will continue indefinitely. And that's obviously not the case.

Greg, are you kidding me? That's the primary way in which I think so many investors make decisions. They don't look at necessarily all of the observations, all the probabilities, all the historical returns or experiences. They look at what happened yesterday or this week, and they extrapolate that experience into the future. It's the one that is, you know, maybe most impactful on our psyche. And so we take that return, we take that experience, whether it's good or bad, and we assume that that pattern will continue indefinitely into the future. And that's obviously not the way the markets work.

The bond math is fascinating. I don't think it's really too well understood, but it is really compelling. Now, I have a question. Do you have an opinion in terms of the yield curve, what's relatively attractive, or that's not per se something that you would recommend? It's more educational to just explain everything.

I think we can do both. I think we can educate and also provide some perspective. And so we're suggesting that right now investors can be paid handsomely by extending duration from a full cash position. And so Jerome Schneider from our firm does a really good job of really rethinking about your cash. Why not all cash is equal. Moving out of money market funds or short-term instruments into things that can pick up a little bit of yield, a little bit more permanence in terms of the coupon that you would receive above and beyond what cash might provide. We would also suggest that investors take a look at the front end of the curve, maybe extending out into the intermediate term. Something around 5 years right now seems to make sense. And there are a variety of ways to do it, Greg, given the fact that we don't necessarily have that crystal ball and we want to prepare ourselves for different outcomes. A couple of ways to get there. Well, so number one is I can leg my way into the market. I can say, look, I'm overweight cash today. It's time for me to redeploy, to take advantage of the higher yield structures that are available today. And so if I'm looking to reallocate, I don't know, 40% of my portfolio, maybe it's 10% this quarter, 10% next quarter. And 10% in the following quarters. And that's dollar-cost averaging or legging my way in. The second way that I can go about it is a barbell approach. I keep some on the short end of the curve, I extend some on the long end of the curve, and I've kind of split the baby in half and I protect myself. And then finally, the way that we think makes a lot of sense, given the uncertainty of where rates may be 6 months from now, a year from now, 2 years from now, is maybe a laddered approach, right? It's the idea that a ladder gives me the best of all worlds. I don't keep all my money short-term. I get the benefit of higher rates by extending into longer-duration assets. But I've always got fresh capital maturing that I can redeploy at the end of that laddering cycle. And that to me seems to make a lot of sense. I get the pickup in return while also protecting myself against the possibility that rates may potentially continue to go up.

And in terms of effective arguments or to deal with clients who are holdouts and really, really stubborn about leaving their money in cash, are there any recommended recommendations and how best to kind of make them loosen the reins and consider redeploying cash for risk assets?

Well, I love to ask questions. I mean, I think that's really part of the process. It's not to offer a definitive opinion. It's analogous to any other professional who might say, let me understand where you are and you know, how you feel today and maybe that we can come jointly to a conclusion that serves your best interests given your objectives. So first question I'd ask is, you know, what is the rationale behind holding so much cash? Is it a concern about market risk? He got burned last year. Is it the possibility that you think rates are going to go higher? Is there an immediate cash need that you have? Let's talk about what your long-term plans are. These dollars that we're holding aside or addressing today, what are these dollars for? Are they to buy that new home in Naples, Florida next month, or are these dollars that are gonna be set aside to fund a 20 or 30-year retirement horizon? As I mentioned a little bit earlier, cash has proven to be a relatively poor hedge against the impact of inflation. Stocks and fixed income assets and alternative strategies have certainly proven to do a better job of that.

Yeah, I mean, the purchasing power of the dollar has been abysmal over the years. I mean, it's, whatever, lost something like 90% of its purchasing power over the past century or what have you. Yeah. But in the short term, obviously people don't really see that so much. Anything else?

Yeah, let's talk about the recency issue that you raised because last year, 2022, was a really difficult period for most investors because Greg, what you and I have been espousing to folks for decades is the benefits of diversification, the one free lunch in investing. Is that every time I diversify my asset classes, I get all the returns of the various components, but I'm simultaneously lowering the volatility of the combined set. Now, diversification does work over time. It doesn't always work all the time. And 2022 was a really good reminder of that point. So we did some work. We went back over 40 years and we looked at the two primary building blocks of most portfolios, stocks and bonds. And so over the 40 observations, we divided them up into 4 quadrants. The first quadrant was years in which stocks and bonds both went up. So I'm not suggesting how much they went up, but they both produced a positive return for investors who allocated capital to the two. Greg, you and I want to live there. We like that when both of the building blocks rise simultaneously. Two of the other quadrants involved years where either stocks went up while bonds went down, or bonds went up while stocks went down. And that proves once again the benefit of diversification. All right, I had a negative return on part of my portfolio, but the positive return on the other helped to offset that. There was only one period, Greg, over 40 years where stocks and bonds both posted negative returns in the same calendar year. And that year was?

Yeah, last year, 2022. Right. And it wasn't like they were down 0.1% either.

No, they were down rather dramatically. And that's, I think, what's weighing on the psyche of many investors and maybe why they're, in addition to the higher rates that are available, why so many investors have chosen to hide out in cash. That memory of the negative experience they had last year is still fresh in their minds. It's that recency bias that you spoke of that is probably suggesting that people are keeping money in cash. Keep in mind when we talk about risk, you know, I need to not just, you know, use the term risk Broadly, I need to understand what does that risk mean to me, Greg? So look, we as financial professionals, we use a terminology that may or may not necessarily resonate with the retail investor. We talk about standard deviation, and standard deviation is the variability of my returns that lead to the central tendency, i.e., how consistent, how volatile is the experience that I've endured in achieving an average result of 8 or 10 or whatever the average might be. I don't know many investors who really define risk in that context. Investors often define risk as, all right, how much money did I lose? I gave you a million dollars, I invested according to the strategy, and my portfolio suffered a drawdown of 5% or 10% or 20%. That's how many retail investors think about risk. But I think there's a better way to talk about risk. And you know what the risk that I prefer to focus on is? It's the risk that is personal to me. I want to retire in 5 years and I want to live on X number of dollars per year. And the risk that I'm facing or trying to protect myself against is the risk that my capital doesn't afford me that lifestyle. The risk that that money's not sufficient to allow me to retire or to spend my money and my time in the way that I want to. The financial advisor's job is to understand what those risks are and to develop strategies for their investors to help them protect against those outcomes.

I think that's absolutely correct, and I think what's really imperative given this is that the objective has to be very clearly defined and delineated so you have a crystal clear vision of what you want, and then you can say, what's the roadmap to get there? What's the risk? The risk is all contextualized there, and you're right that everything else is kind of noise. That's keeping your eye on the prize and what the goal is.

It's hard. Sometimes we get a little I'm a little critical of investors and sometimes how they make poor decisions. The landscape's littered with it. You've seen some of the behavioral studies, Greg. I think Morningstar has done one, Dalbar's done them, and they talk about the returns in the capital markets. And then they talk about the returns that investors in the capital markets have actually achieved.

Oh, and the actual result's always lower, pretty much, right? Always.

Sufficiently, significantly lower. I mean, it's 170 basis points. You might ask, well, John, what's 170 basis points between friends? Do me a favor, compound that, and I do this with my kids, compound that over 20 or 30 years, and that divergence in returns, that cost of emotional decision-making, or let me flip it in another way, the benefit I derive by having a partner by my side who can help me avoid those naturally occurring mistakes short-term decision-making opportunities, that benefit can be really significant.

Absolutely. And I think that often speaks to people. I mean, if you look at— let me frame it differently. If you look at a stock chart, often when it's right at its lowest point, you'll often see incredibly heavy volume. Everyone's given up on the stock and they're selling at the wrong time. And yeah, so people just get the timing, the emotions get in the way and they— they're usually better off staying put, especially if it's an index. In individual stocks, anything can happen. But with indexes, they'll generally hang tighter over time.

And by the way, staying put doesn't necessarily mean ignoring, closing our eyes, and taking a passive approach. I think we can be educated, engaged investors, and we can make changes to our portfolio when it's appropriate. Rebalancing— gosh, I gave a lecture on that this morning. Rebalancing forces me to do what's emotionally uncomfortable, but financially productive. And it's counterintuitive, as successful investing often is. Wait a minute, John, I've got a diversified portfolio. Some assets did really well last year, others did less well. And what you're telling me to do now is to redeploy capital from my winners and to add it to the ones that didn't do so well. That's just not logical to most individual investors.

And it's hard to do for many, yes.

Yeah, it really is.

It is, but I think if you commit to that, to a schedule, whatever that may be, let's say it's annually, that on a relative basis is easier than let's say doing it every 3 or 5 years because then the gains and losses will argue probably be more extreme and it would be even harder given the magnitude of the gains to redeploy towards underperformers.

It is a hard methodology. And I like your idea of doing it maybe on an annual basis, right? I mean, annually at a minimum, I try to do things on an annual basis generally. I change my oil in my car once a year. I change the batteries in my smoke detectors once a year. And I make sure that my advisors and I sit down, review the portfolio, review where we're at, review the performance, review where I'm at as an individual and what changes may have taken place, and then make decisions at that moment in time based on the long-term plan that we've established together, not just short-term market returns.

Excellent. Well, I think we've covered all the bases and then some. Yeah. Anything else or we're good?

No, I can't tell you how much I appreciate the opportunity to sit down with you. I hope that what we've discussed today is helpful to advisors and to investors, not necessarily a definitive recommendation that they can't hold cash or that they're holding too much, but to think about it and what the implications might be given the fact that that over the long term, cash has been an underperforming asset relative to others. And the question that we had asked, how much cash should one have? And what other options might be available to us to help us achieve better long-term returns?

And I like how you framed risk as not— it's not just things floating in the air. It's really specific in the context of what your goals are. That's really how to look at it. So that I thought that was quite instructive. Thanks.

Excellent.

Well, my guest was John Nersesian. For more advisor-specific podcasts, please check out barons.com/podcast. For The Way Forward, I'm Greg Bartalus.

This podcast was brought to you by Wells Fargo Advisors. Looking for a firm your clients can't outgrow? Wells Fargo Advisors offers financial advisors full balance sheet solutions with wealth planning, investment products, banking, and lending that meet the needs of affluent to ultra-high net worth clients. Build your practice your way and on your schedule with independent and employee model options designed to meet your needs today and tomorrow. Learn more at joinwfadvisors.com.