Cash also plays an important tactical function. Not being fully invested today provides the option to invest tomorrow at a significant probability of lower (or higher) prices. This tactical use of cash will remain an important tool in the investor’s kit. Such an option value is a far cry, however, from the theoretical construct of a positive real rate of interest compounded over many years as the foundation of the return on our investment portfolios. For today’s investor, cash and government bonds should become less of a core investment and more a speculative source of potential timing alpha.
Higher-Yielding Real Assets
Asset classes that have historically provided a positive correlation of returns to inflation include commodities, bank loans, high-yield bonds, REITs, and emerging market equities. With today’s fear of deflation, many of these inflation hedges are on sale. An equal-weighted portfolio of the five inflation-hedging asset classes provides higher real yields than a traditional portfolio of domestic equities and core bonds.