Holding wealth in cash makes people comfortable. We like to feel we control things, so having cash in the bank helps us feel in control of our finances. Keeping cash is accessible and carries little perceived risk to investors. After all, cash is king…
But having your wealth in cash holds its own risks. A balanced portfolio will be a mixture of asset classes depending on your unique circumstances; you might have more in cash if you will need it in the immediate future, but otherwise you would have a balance fine-tuned to maximise your potential returns over time.
This is because if you only have cash (be it in the bank, under a mattress, or buried in the backyard somewhere…), you are not going to be able to offset inflation over time. Holding too much cash puts you at risk of ‘cash drag’, which erodes the potential returns of a portfolio.
Having easy access through liquidity does not mean you are exempt from risk. The certainty of cash comes at a cost; you are essentially betting that inflation will not have a significant impact over time, and your money’s value will stay the same. This is unlikely.
Say you have $10,000 in savings. Data shows that after 20 years, even at lower inflationary rates, you will have almost half that; at 3% inflation your buying power would drop to $5,438. At 7% you would see it plummet to almost 1/5 of the original buying power at $2,342.[i]
Imagine saving the exact amount you need for something, only to find that in a year’s time the price has increased, and you no longer have sufficient funds. This is what inflation does. That is why it is important not just to accumulate through savings, but to have a strategy to get your money working harder in the long term.[ii],[iii]
Compound interest rates offered by banks are low. Even term deposits are unlikely to have a lasting positive impact; not to mention you are subject to terms and conditions for early withdrawals. It may sound good (or safer) to have a 6% return[iv] on your lump sum over 12 months. But if you were doing that during period of high inflation – such as the past few years, with inflation as high as 7.3% in July 2022[v] – you would soon see the erosion of that return. If you want to not only keep up with inflation, but out-perform it, long-term investment strategies have historically offered better returns.
It’s not just custom portfolios either. There’s a reason why KiwiSaver schemes are not just savings schemes. It is an investment product, designed to generate higher returns over time.
Another thing to consider for fans of cash is the actual cost of keeping your money in cash. If you are generating very little return over an extended period, you need to be aware of the fees you are being charged for the bank to store your wealth. While card fees or administration fees can seem small, they stack up over time. This is by no means a call for you to take your money out of the bank and store it in a cake tin or similar; but you should be aware how much any action will cost long-term, including inaction.
In the face of volatility, some investors choose cashing up to keep their money where they can see it. This is a fear response. It locks in any losses your portfolio has seen. If you exit at a low point, you will not be able to catch the rise when the markets return to the mean. This is why working with a trusted fiduciary is important; they have your best interests in mind and can keep you on a logical, evidence-backed course when emotions would otherwise cause you to waver.
It is good to have some funds available in cash. I recall in my primary school holidays I would visit my grandparents and see jars of carefully curated expenditure in notes and coins on the kitchen shelf.
Scottish some may say, or children of the great depression others, but it’s wise to always have allocated funds or an emergency fund which can cover you in the event of expected and unexpected expenses. Then, there are short-term savings goals like holidays, travel, or gifting, which you will likely use before inflation has a chance to significantly impact them.
As a wealth accumulation strategy for your financial future, however… you will be better served by a plan which considers your risk appetite, goals, timeframe, and lifestyle. If you’re not sure where to start, get in contact with a trusted, local financial adviser for a chat.
by Nick Stewart (CEO and Financial Adviser at Stewart Group)
· Nick Stewart (Ngāi Tahu, Ngāti Huirapa, Ngāti Māmoe, Ngāti Waitaha) is a Financial Adviser and CEO at Stewart Group, a Hawke's Bay-based CEFEX & BCorp certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver scheme solutions. Article no. 329.
· The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from a Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
[i] Russell Investments: Six month term deposit rate (INR.MBI05.T07)
[ii] Russell Investments: Beware the hidden cost of cash
[iii] https://sorted.org.nz/guides/saving-and-investing/term-deposits
[iv] https://www.interest.co.nz/saving/term-deposits-1-to-5-years
[v] https://tradingeconomics.com/new-zealand/inflation-cpi
