By David Thomson
Is cash always King?
Cash is the Dr Jekyll and Mr Hyde asset class of the investing world. Good Dr Jekyll moments tend to come at times of market turmoil, such as 2022 when fixed interest investments and equity markets both fell. You can sit in cash until times get better. Cash feels cautious; cash feels sensible; cash is king, right?
However, its evil Mr Hyde persona is its terrible track record of maintaining or growing purchasing power over time for investors. For example, during the Global Financial Crisis, November 2007- February 2009 equity markets fell 37% while cash returned 2% relative to inflation.
However, over the period November 2007 until November 2023 cash lost 27% of its purchasing power whilst ‘higher’ risk shares’ rose 134%; more than doubling its purchasing power, even when measured from the height of the market before the fall.
It is of course always useful to hold some cash to meet those unexpected emergencies. Cash is a good buffer against the uncertainties of life. Today it is tempting to want to hold cash that pays a seemingly decent rate of interest after the paltry rates experienced between 2009 and 2021, but the problem is that no one rings a bell telling you when to get out of risky markets and into cash, or when to get back into markets.
In 2022, when fixed interest investments and shares both fell, driven largely by the rapid rise in inflation to double digits and the subsequent increase in both bank base rates and fixed interest yields, some investors were tempted to retreat to cash. After all, deposit holders could receive, say, 5% or so on their cash, so why bother with fixed interest investments or even investing in general?
It is worth noting that often but not always (2022 being a case in point), at times of equity market crisis money tends to flood out of risky assets and into high quality fixed interest investments, driving prices up. In this case, investors receive both capital gains and income. This provides a defensive fillip not available to those holding cash, who just receive the interest they are paid. True, some fixed interest investments will go bust but if you have a diversified portfolio the effect is usually not that significant.
In addition, it is also worth noting that it is very difficult to second guess what the interest rate will be in the future. There is quite a bit of talk in the media that interest rates may come down this year or could it be next year?
Fixed interest investment yields, on the other hand, are driven by the market’s aggregate view of the risks it perceives, which will already incorporate its own collective view on where interest rates will be in the future. It is not always the case that fixed interest investments yields will fall, just because the bank base rate is reduced, as that is already anticipated to some extent and reflected in fixed interest investments prices today. No market timing bell there.
Trying to second guess the market is a challenging sport with few winners. So, if you have a long-term time horizon, say saving money into your pension and trying to maximise your long-term returns then you should have a high weighting to shares rather than cash and stick with that strategy through thick and thin. Cash is not always king.
David Thomson is chief investment officer of VWM Wealth Planning
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