You're about to leave our website

This hyperlink will bring to you to another website on the Internet, which is published and operated by a third party which is not owned, controlled or affiliated with or in any way related to Standard Chartered Bank (Hong Kong) Limited or any member of Standard Chartered Group ( the "Bank").

The hyperlink is provided for your convenience and presented for information purposes only. The provision of the hyperlink does not constitute endorsement, recommendation, approval, warranty or representation, express or implied, by the Bank of any third party or the hypertext link, product, service or information contained or available therein.

The Bank does not have any control (editorial or otherwise) over the linked third party website and is not in any way responsible for the contents available therein. You use or follow this link at your own risk. To the extent permissible by law, the Bank shall not be responsible for any damage or losses incurred or suffered by you arising out of or in connection with your use of the link.

Please be mindful that when you click on the link and open a new window in your browser, you will be subject to the terms of use and privacy policies of the third party website that you are going to visit.

Proceed to third party website
Cash or bonds

From our CIO office

Cash or bonds?

One of the biggest investment debates of our times is whether to own cash or government bonds. In the Developed Markets, one of the most rapid policy rate hiking cycles in history has meant that short-term returns from cash are now higher than what one can earn on a longer maturity bond. Unsurprisingly, this has led to a significant move into cash deposits or money market funds across major economies around the world.

Despite this, many asset allocators (ourselves included) continue to advocate the case for high quality bonds over cash. Are the yield optics sending investors a false signal?

Yield today vs. yield tomorrow

If yields were the only drivers of total investment returns, then there would be little debate on which asset to choose – one could simply allocate to the asset class with the highest yield. In today’s market, that would be cash.

However, one needs to dig a little deeper in the investment world to figure out the real value of the two competing assets. The trade-off is best illustrated with a simple example. In the chart below, we compare three scenarios over a 5-year horizon:

  1. In the first scenario, an investor allocates to cash deposits, which currently yield around 5% over one year. We assume these yields stay relatively high at 5% and 4% in the first two years but fall to 2% thereafter as an economic recession unfolds and, in response, the central bank cuts short-term rates rapidly.
  2. In the second scenario, an investor buys a 5-year bond that yields 4% i.e., less than the return from cash. However, in this case, the investor can lock in the 4% yield for the next 5 years till the bond matures.
  3. In the third scenario, the investor buys another 5-year bond, but one that yields just 3%.
Cash and bonds

The chart illustrates how an investor’s returns pan out over the five-year period. In the first year, cash is clearly ahead with its higher yield.

However, as the one-year cash yield starts to drop in later years, returns fall rapidly. When the investor looks back with hindsight after 5 years, the 5-year bond yielding 4% (1 full percent below the cash yield) ended up being the investment that delivered the highest returns.

Cash only ended up matching returns for a 5-year bond that yielded 3%.

Some cash is prudent, but beware of losing purchasing power

Leaving aside the need for liquidity, some cash can make sense within an investment allocation. This was not really the case for a large part of the previous cycle when cash yields largely went to zero. However, ever since central banks began to raise rates rapidly, cash has become a little more competitive.

Nevertheless, there is little reason to expect cash to do a better job of preserving wealth in real (or inflation-adjusted) terms compared with riskier asset classes. The Optical yield illusion is making many investors respond to the headline yield on cash, but high-quality bonds are the hidden gems that are likely to outperform cash and better keep up with inflation over the coming years.