Best practices for managing cash on the sidelines to mitigate inflation

Key findings

• A quickly accelerating inflation rate coupled with periods of unprecedented market volatility and negative returns have many clients holding large portions of their assets in cash — particularly in money markets
• But not staying invested in the stock market during periods of high inflation could end up adversely impacting their financial plans
• Finding investment options that balance your clients’ desire for protection with their need for growth may help them feel more comfortable about finding an investment strategy that can help them plan for the future

Inflation is on the rise

The inflation rate accelerated at its fastest pace in more than 7 decades last year. It has continued to climb in 2022, with some economists believing that inflation will settle at 3% to 4% and remain at that level for decades.¹ Sudden surges in inflation, such as the one we’re currently experiencing, can lead to periods of unprecedented market volatility and negative returns.

These factors are two of the biggest fears American families have about the future, according to a recent Nationwide® poll.² Of those surveyed, 90% expect inflation or their living expenses to rise within the next year. And 88% agreed or strongly agreed that there would be a recession or economic downturn during that same period.

Another poll³ shows that these concerns already have clients adjusting their behaviors across their everyday lives. 48% of people say they’re eating out less, 35% report they’ve been driving less and 22% say they have been, or are considering, reducing their 401(k) contributions over the past 12 months.

For many clients, these concerns can also trigger an urge to pull out of the stock market. Prior inflation spikes, when driven by unsustainable shocks like the ones we’re seeing now, have generally given way to sharp pullbacks in investing.⁴ And the nearly $4.46 trillion⁵ currently parked in U.S. money market funds is a clear indicator that this is already an issue for many people.

Cash on the sidelines

When clients avoid investing and instead hold a large portion of assets in cash or other low-risk investments (such as money markets, certificates of deposit and bonds) during periods of high inflation, it could ultimately work against their long-term goals.

Staying invested in the stock market, even during times of unprecedented volatility, can help your clients outpace inflation by earning real returns that can build wealth. “Real returns” refer to the returns on their investments after you take inflation into account.⁶

For example, if the return for a bond mutual fund is 2% but inflation is 7%, the investor sustained a real return of -5%. Therefore, portfolios overweighted in cash and bonds may underperform during periods of high inflation. This means that with qualified assets sitting in cash, retirement savings are at risk of being outpaced by inflation.⁷ While this scenario can have a negative impact on all investors, it poses an especially large threat to clients who are nearing or in retirement.

Institutional investors and hedge funds have moved to the sidelines, with cash levels at the highest since 9/11 and equity allocations at the lowest level since the financial crisis. Retail investor flows have told a different story, with the “buy-the-dip” mentality still in play for much of the year. Observers have expected a capitulation of retail flows before a bottom can be reached, but it is possible that the capitulation doesn’t come and a shift in attitudes and positioning by institutional investors can drive a bounce. The degree of pessimism and institutional money on the sidelines, teamed with improving technicals and seasonality, could be a catalyst for a market rebound.

— Mark Hackett, Chief of Investment Research for Nationwide’s Investment Management Group

Putting your clients’ money to work for them

We may not know when a rebound will happen, but it’s important to remember that since 1926, the S&P 500® has had an average annual return of 10.49%.⁸ The goal would then be to help clients looking to mitigate the impact of inflation on their portfolio find investing strategies or solutions that they feel comfortable with and take advantage of this opportunity.

Several investment options, such as registered index-linked annuities (RILAs), are available to help protect your clients’ retirement savings while also providing them with portfolio growth potential.

RILAs help limit your clients’ downside exposure, which is set to a level that they choose, while still providing them with tax-efficient growth opportunities through the performance of an underlying index or indexes.

This unique combination of protection and performance potential may help your risk-averse clients feel more comfortable addressing their retirement planning needs, even in uncertain markets. With this in mind, it might be prudent to discuss a RILA solution with your clients today. You can also leverage Nationwide’s comprehensive services and support to stay up to date on market insights and investor inflation concerns and help keep your clients’ financial plans on track.