From Trump’s trade wars and Brexit woes to the looming threat of a credit rating downgrade in South Africa, rising waves of political and market volatility have left more and more investors wondering whether it wouldn’t be better to keep assets safely tucked away in cash.
And while there are always exceptions to the rule, the simple answer is no. Cash is a traditional safe haven, but it offers safety from volatility – not inflation.
For example, if you keep your money in a fixed deposit account, you may be earning what appears to be a healthy interest rate of 8.5%. But it’s important to remember that this return may be subject to income tax, so if you’re a high-income earner who is subject to the maximum 45% rate, this return may effectively only equate to around 4.7% after tax.
Next, factoring in an inflation rate of 6%, your cash would actually only be earning inflation minus 1%. This means that your cash investment would be earning a negative real return, eroding the purchasing power of your savings over time.
Then there’s the danger that there may be a minimum investment term, which means that you would need to commit your money for two, three or even four years to achieve the high interest rate promised before you would be able to withdraw your investment.
If markets returned to attractive or relatively cheap levels within this time, you would then miss out on the opportunity to move out of cash and buy into the market, owing to a lack of flexibility.
That said, the question of managing your cash allocation and investment risk can be more complicated depending on your individual life stage and circumstances.
With this in mind, below follows a brief discussion of three of the most common questions surrounding cash management, complete with simple strategies for effectively balancing your investments.
What if I have a large cash sum to invest?
While it is common to want to hold onto any large cash reserves such as an inheritance or proceeds from the sale of a business in order to time your entry into the market, especially in times of uncertainty and volatility, investment wisdom emphasises that time spent in the market is far more important than timing the market.
And with a long-term investment horizon, the truth is that entering the market as soon as possible is likely to be to your benefit, as waiting to invest and attempting to time the market means that you could lose out on periods of market recovery and growth instead.
However, investing large sums into the market all at once can be very discomforting, especially during a volatile market cycle, and does raise the risk of mistiming by buying when markets are running high.
A more prudent strategy to deal with this dilemma is therefore to phase in your investment over the period of a few months or even up to a year.
You could, for instance, choose to invest 20% of your capital every two months. That way, you will be able to average out your investment into the market, buying when markets are cheap one month or expensive another.
This approach not only offers the benefit of greater peace of mind, but also ensures that any market falls will only impact the portion of your investment in the market at that time.
What if I need to draw an income from my investments?
In times of uncertainty, many retirees are tempted by the lure of low-risk portfolios targeting moderate returns in the region of inflation plus 2%, or offer lower levels of risk and volatility while still generating some growth, believing that these types of portfolios will enable them to safely draw an income.
But, while this may seem like the perfect compromise, these types of funds still hold some exposure to equity or listed property, and if markets experience a downturn, you could still be forced to draw from your capital for income.
So, if you are a retiree who needs to draw an income from your portfolio, and you are concerned about the impact of potential downturns on your investments, consider building a cash moat to survive on while riding out market volatility.
Instead, calculate exactly how much you would need to live off for a period of time that ensures you feel comfortable, and keep that amount in a cash or low-risk investment.
This savings pot will then represent your cash moat, safeguarding your income against market volatility and preventing you from having to withdraw from your portfolio when markets are down.
You could then keep the rest of your funds invested in a high-equity fund targeting returns far above inflation for superior long-term growth, and simply re-balance the two savings ‘pots’ on an ongoing basis.
In other words, when markets soar, you would be able to remove the cream from the top of your growth investment, or the earnings from interest and dividends, and place this money in your cash pot.
This strategy offers three key benefits in that it offers a degree of protection for your investment capital, enabling you to achieve superior long-term growth on your investments while still safeguarding your basic income.
How should I position my portfolio for heightened volatility?
Markets go through cycles, so your investments may underperform when markets take a downturn. However, over time markets will correct, rewarding those investors who hold their nerve and stay committed to a sound long-term investment strategy.
It’s also vital to remember that there’s a difference between poor performance or investments being down, and losing money.
If you invested R100 into the market, and the market then dives 10%, you would only have R90 left in your portfolio. However, you wouldn’t have lost any money unless you physically withdrew the investment – the loss would only be on paper.
It is therefore key to factor in how much time you have to invest or when you will need to draw from your portfolio before deciding where to invest and how best to allocate your investments, as this will impact your ability to absorb any short-term shocks or volatility.
We may be entering a period of heightened market volatility, but the investors who fare the best are likely to have taken a well-diversified view with their portfolios, carefully spreading their investments across a range of asset classes, including cash.