Should Cash be held in your Investment Portfolio?

By Hamish McPhail, LL.B, GDipBus (Personal Financial Planning), CFPCM, Financial Adviser – Investments, Director of MFAS

The answer is “maybe”. It could fit your circumstances well or prove to be a drag on potential return expectations.

To amplify:

Cash offers liquidity and certainty. You can get your funds quickly and you always know the exact value of your asset. It is a simple asset and easy for all of us to understand given day to day familiarity with savings accounts and term deposits. It is the most secure type of investments (the NZ government guarantees up to $100,000 of deposits should an approved institution fail). More good news is that with the recent rises in the Official Cash Rate (OCR) to 5.50%, the yield for Cash deposits has also increased and for instance deposit rates for terms less than 1 year range as high as 5.65% for the main banks. A year ago, this yield was less than 1%!!

So, Cash is a safe, liquid, investment  and with an attractive yield of above 5% must surely appeal as a part of your investment portfolio especially factoring that it has been a difficult period for property and shares over the last two years?

And this is where the “maybe”” answer comes into play. With NZ inflation running above 6%, a yield of 5.65% seems to be almost treading water. However, when you deduct tax from this at 33%, then the net yield reduces to 3.7% which means its buying power is well below the rate of inflation. For any application of a long-term nature, this means that regardless of the safety and liquidity of Cash, you are losing purchasing power of your money. The impact of inflation on Cash has been likened to rust on steel, a slow erosion with meaningful consequences over time.

Counter this against long term expectations of a well-diversified investment portfolio where the following general returns are forecast to apply:

•             Fixed interest Investments 3-5% real (after deduction of tax and any fees)

•             Inflation based investment (moderate risk) 5-7% real

•             Growth assets 7-10% real.

Certainly, such a diversified portfolio will have ups and downs as we have recently lived through but over the duration of time will substantially outperform the safe house of Cash. The younger investor should be concentrating investments in Growth if they have a 10+ year runway before needing funds. This said, it is important for all to be holding 3 months of expenses as an emergency fund to cover the unexpected and Cash is an ideal safe house here. For the older investor Cash becomes more important as a stabiliser against market volatility especially if income support may be required in the near term. More importantly perhaps is that when income is needed in retirement, at least 18 months of needs should be held in Cash to protect against surprises and give surety of income supply.

The current yields for Cash are welcome but not a panacea for prudent long term investment strategies.