Holding Cash is Not Investing… Or is it?
“Either you sit on the pile of cash, or you continue to grow” ― Gautam Adani
5 min read
Holding Cash is Not Investing… Or is it?
“Either you sit on the pile of cash, or you continue to grow” ― Gautam Adani
5 min read
For many, the notion of investing evokes images of stocks, bonds, or real estate. However, does this mean if you have 500’000 cash sat in your bank account you are not investing and therefore immune to the volatility of the stock market?
The dictionary definition of “investing” (n.) is: “The use of money or capital to purchase an asset or assets (such as property, stocks, bonds, etc.) in the expectation of earning income or profit1″
Well, whilst you do not generally use money to purchase money, cash is an asset and by holding substantial amounts you are making a conscious investment decision that can have both positive and negative impacts to your overall financial wellbeing.
So, it may not perfectly fit the dictionary definition, holding cash is, in fact, a form of investment, albeit one with its own set of dynamics. Read on to find out more about whether you should be holding substantial amounts of cash.
The Real Cost of Cash
Cash serves as a store of value, but its value is not immune to erosion over time, though this is a common misconception about cash: that its value remains static.
When you login to your online banking on a Monday morning you might see 500’000 on your screen. Provided you don’t spend anything that week, you can check your phone on the following Friday morning and still see 500’000 on your screen. However, does this mean you still have 500’000 in your bank account? Well, factually, yes.
However, the truth lies beyond the surface. In the backdrop of inflation, that 500,000, though numerically the same, is likely to have reduced purchasing power tomorrow. So maybe you can buy 2 Porsche 911 GT3 RS model cars today, but next week, month or year, this may reduce to only 1!
This erosion in the number of sports cars you can buy is the silent but persistent effect of inflation on idle cash. It underscores the hidden cost of keeping money in your bank account and highlights the importance of seeking investments that can potentially outpace inflation to preserve and grow wealth over time. For more information about the impact of inflation, view our article here.
Returns on Cash
Earning from cash holdings typically involves interest income offered from various financial instruments like savings accounts, certificates of deposit, or money market accounts. When you park your money in a bank account or one of the above, financial institutions (typically a bank) compensates you with interest payments for allowing the institution to use your funds.
Savings accounts offer relatively low but steady interest rates, providing account holders with a modest return on their deposits. Money market accounts, akin to savings accounts but often offering higher interest rates, invest in short-term, liquid, and low-risk securities like government bonds or commercial paper. These accounts provide competitive interest rates whilst preserving liquidity, making them attractive options for those seeking relatively higher returns than traditional savings accounts.
Nevertheless, the returns generated from cash holdings are often conservative, and whilst they can provide stability and security, they might not suffice to counter the effects of inflation, which as mentioned can erode the purchasing power of your earned interest over time. In fact, in times of low-interest rates or when the inflation rate exceeds the interest earned, the real return on cash becomes negative and so you are guaranteeing a loss each year.
It is definitely vital to keep some of your funds in cash for accessibility when you need it, though typically enough to cover 6-months of your expenditure is likely to be sufficient.
Cash in Your Investment Portfolio
When creating an investment portfolio, cash actually plays a pivotal role. It acts as a buffer, a tactical tool, and a source of opportunity. A strategic allocation to cash within a portfolio provides liquidity, ensuring readily available funds for immediate needs, such as covering expenses or seizing investment opportunities arising during market downturns. This liquidity allows investors to maintain financial flexibility, capitalising on moments of market volatility or taking advantage of undervalued assets without the need for selling other holdings at disadvantageous times.
However, whilst cash can allow for stability and accessibility, it comes with a trade-off in terms of potential returns. As mentioned above, cash returns primarily stem from prevailing interest rates, which often lag behind the pace of inflation, resulting in a loss of purchasing power over time. Despite its importance as a tactical and liquidity tool, holding excessive cash for prolonged periods could impede the portfolio’s overall potential for growth and limit the ability to counter the eroding effects of inflation. Balancing the advantages of liquidity and stability against the necessity for potential returns becomes imperative in constructing a well-diversified and resilient investment portfolio.
Cash vs Equities
Cash and equities represent contrasting facets of investment, each with its own merits and drawbacks. Holding cash serves as a protective measure during market volatility, providing a cushion against downturns and allowing investors to swiftly navigate unexpected financial needs. However, while cash ensures safety, its returns are typically modest and might not sufficiently outpace inflation, leading to a decline in real purchasing power over time.
Equities, on the other hand, embody ownership in companies and the potential for significant capital appreciation. Investing in stocks grants shareholders a stake in a company’s profits and growth potential. Equities historically outperform cash over extended periods, offering the possibility of higher returns. Yet, stocks carry higher risk due to market fluctuations and economic uncertainties. They can be volatile and subject to market sentiment, making them prone to short-term fluctuations and potential losses. Despite this, the potential for long-term wealth accumulation often draws investors towards equities as, historically, cash has been greatly outperformed by equities (and other asset classes, too).
When considering cash versus equities, weigh your risk tolerance, investment horizon, and financial goals. Whilst cash allows for stability and immediate access to funds, equities offer growth potential but come with higher risk. Holding cash may often lose to inflation, but it is possible that in a bad period your other investments may decline in value even further. Finding the right balance of cash and equities (or bonds, real estate etc.) is crucial in constructing a diversified portfolio that aligns with your risk profile and long-term investment objectives.
Cash is Investing
In reality, holding substantial cash is often a deliberate decision (or perhaps you haven’t got around to investing yet?) and is an investment in cash rather than a diversified portfolio of equities, bonds, commodities, real estate and, yes, cash etc.
It is up to you to decide what style of returns you wish to achieve, and whether they can be achieved by holding cash or may require a well-structured investment strategy for your portfolio.
Patterson Mills are here to help you make that decision and ensure your portfolio is putting you on the right path to future financial success. So, get in touch with us today and book your initial, no-cost and no-obligation meeting, you will be pleased that you did. Send us an e-mail to info@pattersonmills.ch or call us direct at +41 21 801 36 84 and we shall be pleased to assist you.
Please note that all information within this article has been prepared for informational purposes only. This article does not constitute financial, legal or tax advice. Always ensure you speak to a regulated Financial Adviser before making any financial decisions. Past performance is not indicative of future returns.
1Oxford English Dictionary, 2023
