##Summary
- In early 2020, Ray Dalio's stance, which said "cash is trash," changed. Cash is viewed as attractive.
- Ray Dalio says that the attractiveness of cash is judged through relative comparison with the direction and level of interest rates and the expected returns of other assets.
- It is not a special content, but it is something that people who invest must know and reflect on.
- It was a good study because the article revealed a concise and firm attitude toward my principles.
##reference
- I am not a professional translator, and I translated the letter for study purposes.
- Aided by AI translation and includes paraphrases
- We tried to translate the original text as much as possible, but simplified any rhetoric that was unnecessary for understanding or was overly awkward.
- For detailed information, refer to original text
##Original text (translation)
##Why cash is attractive now (and not trash)
For the past few months I have been saying “cash is good.” This got a lot of attention as it runs counter to my "cash is trash" statement from early 2020, and some people wanted to know why I changed my mind.
To be clear, I have judged and communicated the attractiveness of cash based on the interest rates at the time each time. While interest rates were “crap” (less than 1%) in 2020, they have been pretty good lately (around 5.5%).
Cash is sometimes good and sometimes bad. I use a variety of metrics to make my decisions, and rather than just give you the right answer, I want to help you figure it out for yourself. I'm going to share a simple and pretty good, if imprecise, way to evaluate the attractiveness of cash and bonds. My actual process is a bit more complicated, but this simple version will help explain my thinking. I worry that it may still be too complicated for some people. Before we dive in, I want to make it clear that this article is about comparing the relative attractiveness of asset classes, not investing to generate alpha (that's a very different topic). Anyway, let's get started.
I consider the following items important in evaluating the attractiveness of cash (broadly, bonds).
- Interest rate level compared to expected inflation rate (i.e. real interest rate)
- Will inflation and growth be higher (tightening factor) or lower (easing factor) than the Fed wants, andis it likely that the Fed will tighten or ease interest ratesaccordingly?
- How attractive is cash interestrelative to the attractiveness of other investmentsbased on expected returns?
- Supply and demand of cash and bonds
Now let's get a little more specific.
In principle, I would like to lend (i.e. invest) cash in the following cases:
a) When interest rates rise and the risk-free rate is more than 1% higher than the inflation rate (the higher it is above 1%, the more I want to lend)
b) When the real interest rate reaches or exceeds the economy's real growth rate -- that is, when the interest rate exceeds the economy's total growth rate (i.e. the sum of inflation and real growth rate). The more I exceed the rate of inflation and growth, the more I want to borrow, and vice versa (i.e. when I'm short on cash) the more I want to borrow.
To be clear, the above description is a baseline for investing in risk-free (i.e. U.S. Treasury bonds) assets. Naturally, higher-risk debt requires a higher interest rate, and the additional interest rate varies depending on the riskiness of the debt. I prefer "cash" (meaning short-term bonds with maturities of less than two years) because you can get a decent return without losing principal, and if interest rates continue to rise, your returns will increase.
On the other hand, I don't like holding bonds (especially long-term bonds with a maturity of 10 years or more). Because when interest rates rise, bond prices are likely to fall. That's why I said in early 2021 that it wasn't a good idea to hold on to bonds when Treasury yields were roughly 1%. At that time, interest rates were about 1.5% below the expected inflation rate, and given expected inflation and growth changes, there was a good chance that interest rates would rise.
For long-term bonds, the real interest rate should be about 1.5-2% higher than the expected inflation rate (current estimates are about 3.5%) and the real interest rate should be higher than the real growth rate (about 1%). Therefore, if only the above factors were considered, interest would have been in the government bond yield of approximately 5-5.5%, but these are not the only decisive investment criteria.
We also look at the supply and demand for bonds and adjust our estimates. This is because the expected supply of government bonds is large (because the government's deficit is large) and the demand is small.
This is because the potential supply of government bonds to be sold is currently large (due to the government's large deficit) and the potential demand is expected to be low. (Mostly because foreign banks or central banks hold large amounts of money, and the resulting losses are enormous, they are worried about what is going on politically, socially, and economically in the United States. Also, U.S. bond holders in some countries are worried about "sanctions" and that they may not be able to cash out their U.S. Treasury holdings.) So, until the stock, economic, and inflation crises ease, interest rates should be around 5-5.5% for Treasury demand to recover, at least. I think. For this reason, cash (which has no price risk and will become more attractive as interest rates rise) appears relatively attractive compared to bonds. My approach to stocks may be a little more complex than to cash, but I'll teach you a simple and pretty good, if imprecise, way to value stocks.
My approach is quite complex as I look at the returns, dividend yields and price-to-earnings/growth prospects of individual companies/stocks. We also look at the supply and demand of each. These are then aggregated to get a perspective on the overall market (e.g. S&P 500). Using overall market returns is simpler but less accurate. So what does this mean?
These results show that the stock market is currently offering expected returns of 5-5.5%. This is too low compared to bond yields. (In particular, if interest rates rise further, stocks are likely to fall.) The stock market now offers an expected return of around 5-5.5%, which is significantly lower than bond yields. (Plus, stocks tend to fall because bond yields can go higher.) Cash's yields offer virtually no price risk, making it quite attractive not only compared to stocks but also bonds. This makes cash returns, virtually free of price risk, look quite good compared to potential bond returns as well as potential stock market returns. Since none of this is exact (for example, if bond yields rise to 5.5% or 6% and stock yields rise further, bonds and stocks could fall by that much), cash offers good returns without the price risk. I find cash “pretty good” because it keeps my money safe.
Once again, no calculation can accurately predict the future, and the deviations in these estimates can sometimes be large. So I prefer to act when the return differentials are relatively extreme. For example, when interest rates were at their lowest point, he said 'cash is trash'.
Perhaps the information I gave you may be more confusing and perhaps even more dangerous, but I have given you the high-level information in a short answer about my judgment method. Hope this helps.