“Risk” is a loaded word, with somewhat negative connotations. Most people only focus on downside risk, and when we hear about “risky” investments, it’s usually in the context of penny stocks, cryptocurrencies, and other speculative instruments. The accepted meaning of “risk” in financial terminology, however, is generally to express standard deviation, which encompasses both possible underperformance and outperformance relative to the average expectation for investment returns. After all, risk can lead to both loss and gain, otherwise no reasonable investor would take any risk.

If you’re casually familiar with the capital asset pricing model (CAPM), you’ve heard the term “risk-free rate.” The risk-free rate (RFR) is a theoretical measure of an investment with zero risk over a given period. Typically, the 3-month Treasury bill (T-Bill) is used to represent the RFR, given the nearly zero chance the US government will default on its short-term debt. The 3-month T-Bill is currently around 4.8%, the highest yield since 2007. Earning 4.8% a year with zero risk certainly looks enticing, and investors have taken note, fanning cash into money market funds that now total a record $5.2 trillion. In investor deposits.

A recent research note from JP Morgan’s global equity strategists suggested that investors should underweight U.S. stocks in favor of “risk-free” short-term holdings like the 3-month T-bill, arguing there is too much uncertainty as the Fed struggles to keep up. Monetary policy against an unstable geopolitical backdrop and weak global growth. This is a compelling argument and for risk-averse investors, collecting around 5% returns with almost no downside certainly provides peace of mind in a stressful market. With the Fed announcing that it will keep fed funds rates around or possibly above 5% for the rest of this year, investors can lock in similar returns, get an early start on summer vacation, and check back in 2024, right?

Of course, things are never simple. The risk-free rate is actually the “nominal” RFR, and fails to account for the elephant in the room, inflation. The so-called “real risk-free rate” is calculated by adjusting for inflation. There are many inflation measures, but if we use the Fed’s favorite measure, core personal consumption expenditures, which is currently 4.6%, we can see how the real “risk-free” return has essentially fallen to zero. While it may sound less attractive, knowing that 3-month T-Bills offer an opportunity to avoid losing purchasing power to inflation can still be a winning strategy for risk-averse investors.

Apart from inflation, leaving the equity market also carries the risk of opportunity cost. It’s been more than 15 years since the 3-month T-bill yielded more than 4.8%, so some new investors may have never experienced a market like this, and other, more experienced investors may have forgotten that stocks can still appreciate at higher interest rates. setting. Surprisingly, this is actually more common than not when looking at returns going back to 1981. For example, the chart below shows 18 years since 1981 in which the 3-month T-bill yield averaged 4.8% or higher during the annual period. The S&P 500 had positive returns in 15 of these 18 years, and its annualized return exceeded the corresponding average 3-month T-Bill yield in 13 of the 18 years, delivering double-digit returns in all such cases.

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