Based on the response to my recent video, plenty of people seem to be wondering why they would bother with risky stocks for their long-term investments when they can earn 5 per cent on their cash with a high-interest savings account (HISA) ETF?
People feel good about the nominal – unadjusted for inflation – stability of HISAs, but HISA exchange-traded funds are counterintuitively risky for long-term investors, even at a 5-per-cent yield.
(It’s important to be clear that I’m talking about long-term investments. Holding cash in a HISA for emergencies or a planned purchase makes sense.)
It’s common for investors to reduce their exposure to risky assets, such as stocks, when interest rates are high. And while the idea of getting a “safe” 5-per-cent return is compelling, the nature of risk changes over time.
One of the big problems with HISAs for long-term investors is that HISA rates are not guaranteed. A 5-per-cent HISA yield today tells you little about the HISA rate that you will earn in the future.
New ETF focuses on ‘blue economy’ of marine, freshwater resources
A common response to this is that you can collect the 5-per-cent yield while its available and switch to other investments if rates decline, but this misses an important property of longer-term assets.
As a long-term investor, falling interest rates are a major risk. They mean that you need to save more or spend less to meet your long-term goals, all else being equal.
Stocks and bonds hedge some of this risk since their prices are sensitive to changes in interest rates. When rates fall, stock and bond prices tend to increase, offsetting some of the effect of the fall in rates.
Prices on HISA ETFs, on the other hand, will not respond to changes in rates. This is one of the reasons their value is stable. That stability is great for short-term investors – you want to make sure your savings are available when you need them – but counterintuitively risky for long-term investors.
HISA ETFs also have lower expected returns than stocks, even when HISA rates are high. If we take a global sample of five-year rolling real stock returns from 1900 through 2022, we see that when short-term rates have been high, stock returns have followed suit.
Low expected returns increase the risk of inflation eroding the purchasing power of cash. This is especially problematic at long horizons.
Between exposing long-term investors to the risk of falling expected returns, and lower expected returns than stocks in all environments, it should not be a surprise that the long-term track record of HISA ETFs leaves a lot to be desired.
Looking at historical data from around the world for 38 countries, the estimated probability of losing purchasing power in investments such as HISA funds is about 37 per cent at a 30-year horizon compared with 13 per cent for domestic stocks and 4 per cent for international stocks.
HISA yields are high right now, and I know this has a lot of people wondering why they would bother investing in stocks. But a HISA has low and unpredictable expected return, leaves you exposed to the risk of falling interest rates over the longer term and it has a lower expected return than stocks in all rate environments.
I know some people will read this and think they will hold HISA ETFs until stocks drop in value and then seize the opportunity to buy in; they will “buy the dip.” We looked at this strategy in a 2021 paper and found it underperforms a simple buy-and-hold strategy around 60 per cent of the time, and by a wide margin on average.
Taken together, HISAs are arguably a riskier long-term investment than stocks even when rates are high – a statement strongly supported by historical data from around the world. Long-term investors are best served maintaining exposure to their target long-term asset allocation rather than being enticed by current HISA rates to make tactical changes.
Do you have a question for our adviser? Send it to us.
Benjamin Felix is a portfolio manager and head of research at PWL Capital. He co-hosts the Rational Reminder podcast and has a YouTube channel. He is a CFP® professional and a CFA® charterholder.
