Cash has an opportunity cost: In 2022 the Federal Reserve began raising interest rates more aggressively than at any point in decades. As a result, for the first time in a long time, cash appears to be a worthwhile “investment”. Of course, having cash on hand for day-to-day expenses and potential emergencies is an important part of financial well-being.

That said, it is also important to consider the opportunity cost of holding too much cash. Throughout history, peak cash yields have not persisted and returns from other fixed income instruments and the stock market have typically outpaced the return on cash. In other words, while cash is an important part of any portfolio, excess cash should be deployed into the market.

TOP: The power of dividends and compounding: In this simple illustration, $10,000 is invested two ways: first into the S&P 500 without reinvesting dividends, and second into the S&P 500 with dividends reinvested. Shortly after investment, there is minimal difference in performance. However, after a long enough period of time, the magnitude of outperformance of the portfolio with dividends reinvested becomes apparent.

BOTTOM: Investing in risk assets is critical: Many investors shy away from the stock market, unwilling to take on added risk. But this chart shows a staggering difference in the value of $10,000 invested in a variety of different asset classes over time, ranging from low-risk T-bills to U.S. small cap stocks.

It’s always darkest just before dawn: Market timing can be a dangerous habit. Sometimes, investors think they can outsmart the market; other times, fear and greed push them to make emotional, rather than logical, decisions.

When investors feel gloomy and worried about the outlook, their natural tendency is to sell risk assets in general and stocks in particular. However, history suggests that trying to time markets in this way is a mistake. Over the last 50 years, there have been nine distinct peaks and troughs in the University of Michigan Consumer Sentiment Index. On average, buying at a confidence peak yielded a return of 3.5% while buying at a trough returned 24.1%.

Seeing through the noise: Every year has its rough patches. The red dots on this chart represent the maximum intra-year decline in every calendar year for the S&P 500 going back to 1980. While these pull-backs cannot be predicted, they can be expected; after all, markets suffered double-digit declines in 25 of the last 44 years.

However, despite the many pull-backs, roughly 75% of those years ended with positive returns, as reflected by the gray bars. As a result, volatility is unlikely to derail a long-term allocation. Investors therefore need a plan for riding out volatile periods instead of reacting emotionally.

Diversification has served its purpose: The last 15 years have provided a volatile and tumultuous ride for investors, with multiple natural disasters, numerous geopolitical conflicts, a global pandemic and two major market downturns.

Yet despite these difficulties, cash was among the worst performing asset classes over this time period. Meanwhile, a well-diversified portfolio of stocks, bonds and other uncorrelated asset classes returned roughly 8% per year over this time period (and around 220% on a cumulative total return basis).

Good things come to those who wait: While markets will always have a bad day, week, month or even year, history suggests that investors are less likely to suffer losses over longer periods.

This chart illustrates that concept. While one-year stock returns have varied widely since 1950, a blend of stocks and bonds has not suffered a negative return over any five-year rolling period over the past 70 years.