Life can be thought of as a journey of trade-offs. Choosing to do one thing often means we are unable to do another. And this can be frustrating.
Holding some of your investment portfolios in cash and term deposits is one of life’s trade-offs.
If I hold cash or term deposits, I have to accept a low return and forgo investing in assets that may have a higher return. Many clients find this frustrating.
But the “return” on cash is not the same as the “value” of cash.
The long-term “return” on cash and term deposits is almost always less than the long-term return on shares or property. In the current environment, cash and term deposits are paying as low as 0% pa and maybe, if you’re lucky, up to 1%. The average return on cash for the last 10 years would be approx. 3% pa whereas the 10-year return on shares and property is more like 10% pa.
So why would I hold cash and term deposits? What is the “value” of cash and term deposits?
Firstly, the “value” of cash is that it is largely the only “currency” that we can use to buy the things we everyday things that we need and want (with the limited possible exception of cryptocurrency and gold). If we don’t have cash, we either can’t buy what we need or want or we need to sell something to generate some cash. So we need to hold cash for everyday use. For our retiree clients, we tend to hold enough cash and term deposits such that along with estimated income (in a down market) they have enough cash to last 4 years without having to sell any growth assets. This allows markets to recover before there is a need to top up depleted cash reserves.
Secondly, cash doesn’t move up and down with equity or property prices. This means by holding some cash and term deposits, that your overall portfolio won’t move up and down to the same extent as the market which can be especially comforting in times of large market falls like the GFC or Covid 19 market events. Typically we “feel” the pain of market losses far more than the “pleasure” of market gains and so dampening the negative returns can help you stick to your long-term investment plan and take advantage of compounding returns.
Another benefit of holding some cash (especially towards the top of the market) is that you can deploy your cash into good investment opportunities as they arise, rather than having to sell something in a down market. Good investment opportunities don’t arise all the time and so you want to be prepared for them when they do.
Finally, cash provides peace of mind.
You have money when you want it and the certainty that you can ride out market ups and downs.
@Paul Barrett of Absolute Wealth Advisers is one of Australia's most experienced Private Wealth Managers. He is a financial expert in high net wealth divorce, estate management and inheritance. Contact him here