How much cash should you hold in your portfolio?
During periods of sharemarket volatility, many investors turn to the perceived safety of cash investments.
But does holding a substantial portion of your investments in cash make for a sound investment strategy over the longer term?
Why cash?
Cash is generally considered a defensive, low-risk but also low-return asset class. Generally, cash accounts are used within an investment portfolio to collect income and to pay expenses or rebalance portfolios. Many investors put enough in cash investments for an emergency fund or to cover expenses in case other investments go through a weak period. That way, they can gain immediate access to funds without having to draw on other underperforming investments.
Investors who don’t need immediate access to all their funds can generally earn higher returns by investing in longer duration fixed income investments, such as bonds, or in other asset classes, such as shares.
Therefore, cash usually forms only a small part of a well-structured investment portfolio.
When deciding where to invest your cash, make sure you’re comfortable with the timing and terms. There are often fees and charges for breaking the term if you need to access your cash for any reason.
Think long term
Cash has an important role in all investment portfolios. For many investors, beyond the need to securely park and generate a return from cash reserves, is an equally important need to manage multiple income streams and transactions easily and effectively.
While cash is seen as a ‘safe haven’, it’s also limited in its ability to generate returns above inflation, restricting real capital growth over the longer term. History shows that cash has the lowest expected real (after-inflation) return in the long run compared with a diversified investment strategy which includes asset classes such as shares and property.
Therefore, if you want to grow your wealth above the rate of inflation, you’ll have to take on some investment risk.
Another thing to keep in mind is that cash investments don’t receive the favourable tax treatment available through other investments. Any interest earned is fully taxed at your marginal tax rate with no capital gains tax (CGT) concessions available.
Regardless of the speculative views on whether interest rates will rise or fall, a large long-term allocation to cash is unlikely to provide the greatest return.
To grow your wealth over time, a well-diversified portfolio investing in many asset classes, alongside a smaller allocation to cash may be a more suitable way to achieve your objectives.
For advice on a cash strategy that best suits your individual needs and circumstances, contact us today.
Options for cash investments:
Term deposits lock your cash away for a set period. They have low functionality but tend to offer a better interest rate over the duration of the set-term than you may receive from other day-to-day bank accounts. Cash management accounts and trusts are used by investors. These provide a cash hub to help you manage all your cash flow, including investments. Cash management trusts (CMTs) pool investors’ money into high-yielding money-market instruments that are normally only available to professional investors, while cash management accounts (CMAs) are individual bank accounts. Both tend to have a higher minimum investment, such as $5,000. |