A stash of cash or investment?

So, you are holding cash: Is it your emergency fund? Is it your savings? Is it the dry powder in your investment portfolio?

It may feel comfortable, but over time it can erode your purchasing power and expose you to inflation risk. Let’s look at why leaving too much of your wealth in cash long term may not be the best decision, and what you can do instead to achieve your financial goals.

Cash has lower expected returns compared to other asset classes, such as shares, bonds, real estate, or commodities.

Data from Morningstar shows this, albeit using US data, but given the US is the largest economy/financial market and much KiwiSaver money is now invested offshore, it’s a reasonable benchmark.

The average annual return for cash (measured by the 3-month Treasury bill) from 1926 to 2020 was only 3.3%, while the average annual return of shares (measured by the S&P 500) was 10.2%. This means that $1 invested in cash in 1926 would have grown to $21 by 2020, while $1 invested in shares would have grown to $9,237. That is a dramatic difference in wealth accumulation over time.

Cash also has a negative real return after accounting for inflation. Inflation is the general increase in the prices of goods and services over time, which reduces the purchasing power of money. The average annual inflation rate from 1926 to 2020 was 2.9%, which means that the real return of cash (after subtracting inflation) was only 0.4%. Consequently, $1 invested in cash in 1926 would have lost 95% of its value by 2020, while $1 invested in stocks would have increased its value by 1,600 times.

Cash is not always a good hedge against market volatility or downturns either. While cash is easily accessible and offers stability during periods of market stress, it also prevents you from participating in any market recovery and growth.

For example, during the global financial crisis (2008-2009), many investors sold their stocks and moved to cash, hoping to avoid further losses. However, by doing so, they also missed out on the subsequent rebound and rally that followed. From March 2009 to December 2020, the S&P 500 returned 18.4% per year, while cash returned only 0.5% per year.

After 2022’s dismal performance, cash might look tempting. While there has been some recovery this year it has not been without unsettling volatility. If you sat in cash over the last year until 31 October, you got a fairly decent NZD cash rate of 5.07%. Sounds good, but you would have missed the 10.37%% rise in the MSCI World share Index in New Zealand Dollar terms.

So, what should you do instead of stashing cash over the long term? The answer depends on your risk tolerance, time horizon, and financial objectives.

After allowing for emergency funds and any cash needed in the next 2-3 years, a general rule of thumb is to look to diversify your portfolio across different asset classes and sectors AND to rebalance it periodically to maintain your desired allocation and risk level. You should also have a clear investment plan and stick to it, regardless of market fluctuations or emotions. By doing so, you can increase your chances of achieving higher returns, preserving your purchasing power, and reaching your financial goals.

We at Collinson Wealth Partners are only too happy to explore these options with you. We can help prioritise your goals and uses for cash that you may currently have sitting in your account or current investment portfolio.

The information contained in this publication is general in nature and is not intended to be personalised financial advice. Before making any financial decisions, you should consult a professional financial adviser.

Collinson Wealth Partners believes the information in this publication is correct, and it has reasonable grounds for any opinion or recommendation contained in this publication on the date of this publication.