Cash is so hot right now.
Everyone seems to piling their savings into cash like products. Savings accounts, term deposits, and so on.
Just look at the data from the Reserve Bank.
The amount of money in cash is up by a whopping 25% year on year.
Whereas listed shares are only up under 10%, despite many international funds and shares going up in price more than 10%. Meaning it is likely the amount that each individual is investing is lower than one year ago.
Cash is clearly in favour at the moment.
The thinking is with interest rates much higher than they were a year or two ago, it makes sense to invest in cash.
Maybe there is also a bit of worry from people about the current state of the economy.
But worrying about a recession is as old as time.
There are always reasons to be pessimistic.
This obsession with cash is not going to do any favours for you over the long run.
The risks of holding too much cash
You may be salivating now that returns are 5 or 6%, but at what cost?
You always need to think of the opportunity cost of your financial decisions. There is never a free lunch (except for maybe KiwiSaver contributions).
What are you giving up for this comfort of cash returning a whopping 5%?
From March 2023 to March 2024, the S & P 500 index has increased in value by around 30%.
I get it. Shares and cash are different financial beasts. Shares are highly volatile and carry a lot more short term risk. Cash is a much safer asset in terms of volatility. But investing done right is not too risky.
And why are you investing in cash? If it is because you need the money in the short term that is a great decision. However, the increase in cash savings is proof that many are investing for the returns. Well, if you are investing for returns, then you have severely underperformed the performance of shares in the last year.
If you have time on your side as an investor, then risk taking is a requirement. Otherwise, your money will not outpace inflation. You won’t get ahead.
I know that the last year in the share market is a bit of an anomaly. However, over the long run, the share market still significantly outperforms cash. The difference even just a small difference in returns can make is significant, let alone a larger difference in returns.
Below is the difference between $1,000 a month invested at returns ranging from 5% to 8% over 10, 20 and 30 years.
First, 10 years:
$1,000 a month invested for 10 years at various investment returns
20 years:
$1,000 a month invested for 20 years at various investment returns
And 30 years:
$1,000 a month invested for 30 years at various investment returns
Small percentage changes and longer timeframes making differences in the thousands, potentially hundreds of thousands.
You may be thinking you are only holding cash for a little while as interest rates are higher. The problem with this is what if share prices don’t pull back? When you are ready to buy back into shares, they may have had a lot of their gains never to return. When do you buy in now?
Market timing very rarely works. Especially not on a consistent basis. The best thing for you if you are worried about the relationship between risk and return is to have your short term money in cash and your long term money in shares and other growth assets. Leave the market timing to those who have nothing better to do with their time and are ok taking on greater odds of under performing the market. If you have a good investment plan, sitting back and doing nothing is the best thing for you.
Cash for short term needs is great. It can also be good if you are expecting an opportunity, or are uncertain when you will need the money.
Just be mindful about why you are holding more cash though. If it is for the returns, then you may need to consider what you may be missing out on. It could be costing you a lot of future money.
If you need an investment plan or recommendations , then get in touch today.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here