Cash money is King

When Is Cash King?

South African interest rates are still high relative to our prevailing inflation rate. This is because the Reserve Bank has protected the Rand during the last few years of poor economic growth and high political volatility. Inflation is steadily decreasing and now the Reserve Bank has followed suit with a 0,25% cut, which is likely to be the start of much lower interest rates going forward. This is a worldwide trend.

Overextended periods of time, a cash portfolio after tax will not keep pace with inflation

For the past 5 years, South African investors holding cash have enjoyed satisfactory returns when compared to equities – and with far less volatility. However, if we look back a little further a very different picture emerges. The graph below, which goes back to 2000, shows that over the long-term cash substantially underperforms equities and bonds.

We have detailed financial information on South African and developed markets going all the way back to 1900. Since it is reasonable to assume that the future will be similar to the past, this provides us with valuable insights on what returns can be expected from different asset classes. Based on this data we can expect the cash to provide a return of inflation + 1%, whereas equities should generate inflation + 6% returns over the long term.

Holding cash must always be for very clear reasons, rather than a panic response to market uncertainty

In the modern economy, many investors have a 60-year time horizon – 30 years of saving before retirement and 30 years living off savings in retirement. Since cash earns interest which is taxable as income, it is easy to see that over extended periods a cash portfolio after tax will not keep pace with inflation. This means that holding cash must always be part of a well thought out financial plan.

If, for example, your objectives are capital preservation and high liquidity to cover short-term needs, then cash is an ideal investment. However, investing predominantly in cash as part of a long-term strategy is unlikely to deliver the required returns to grow your wealth.

When should you hold cash?

Sometimes it makes sense for investors to hold cash and lower risks. For instance:

  • When making a large lump sum investment into a growth or balanced fund it is prudent to phase in the investment over time, particularly if the stock markets are expensive.
  • If your life circumstances or your investment time horizon has changed and you need to lower your risk profile.
  • When you start to draw a regular income from your investments a cash holding can lower volatility, which is essential in managing retirement savings.

The best strategy for most investors is to invest in a balanced fund which has multiple asset classes. This way the decisions of when to hold cash or equities are made for you by a team of professional fund managers.