Albert Einstein defined insanity as doing the same thing over and over again while expecting different results.
Many traders fail to learn from well-documented historical experience. Instead, they violate the Einstein rule of insanity.
The chart below shows the nominal, the after-inflation, and the real (i.e., tax + inflation adjusted) total return on stocks, bonds and cash. These results cover the 86 years from January 1, 1926 to December 31, 2012.
Fixed-income (bonds) registered slightly positive, but unexciting, real returns - only 0.6%. At that long-term growth rate, it would take about 120 years to double your true buying power. (If you think 120 years seems like a long, long time, relax - the second 60 years fly by much faster than the first sixty!)
Cash, represented by the Morningstar/Ibbotson 30-Day US Treasury Bill Index, was the worst performing asset class. ‘Money in the bank’ was anything but. The long-term, real rate of return on cash was negative.
Equities were the clear winner. True believers doubled their after-tax, inflation-adjusted buying power every sixteen years.
Keeping 10% - 20% of your nest egg in cash at all times would sentence that portion of your net-worth to permanent ‘no-growth’ status. The reduced volatility might make you feel more secure, but it will simultaneously impede your chance for success.
Why bet on asset classes that have proven to be poor performers? History tends to repeat itself.