The Yahoo! Finance headline just after Christmas was quite clear: ‘The sexiest investment for 2019: Cash.’
Thus far, the article could hardly have been more wrong. Year to date, global equities have gained about 15%, while cash has made hardly anything. Not so sexy now, Yahoo!
But it was expressing a widespread view. When times are tough and markets have been falling, as they were in the final quarter of 2018, many investors run to cash. Cash feels cautious. Cash feels sensible. Cash is king, right? You can sit and wait in cash until times get better.
Now it’s always useful to have some cash in your portfolio. Cash helps you to deal with unexpected demands and everyday crises. Cash is a buffer against the uncertainties of life.
But cash is also a danger, which investors often don’t appreciate. One problem is that it can get eaten up by inflation. In the UK, for example, returns on cash has been lower than inflation in every year since 2009.
If you had put £100 in the bank in January 2009, it would now be worth about £79 in real terms (taking consumer inflation into account). Over the last ten years, holding cash would have chomped up one fifth of your buying-power – even before taxes and bank charges.
A loser since the financial crisis
Normally, cash earns more than inflation. In the UK, this was true in every year between 1980 and 2008. Since the global financial crisis, though, cash has been a consistent loser. With cash rates still low, it’s downright reckless to hold a cash ISA for a few years.
The huge advantage of cash is that it’s immediately available. You can go to the bank and get your money right away.
But most investors don’t need this facility. If you’re in your thirties your expected lifespan is another fifty to sixty years. You are a very long term investor indeed.
If you retire in your early sixties and are reasonably healthy, you can expect to live for twenty or thirty years more. Many retirees should be investing a portion of their pension pots for the long term.
And long term investors should be trying to maximise their long term returns. Most of them should hold big chunks of equities; the best performing asset class over a decade or two.
Between 1900 and 2018, for example, it’s been estimated that UK equities gained 4.5% per year after inflation. Even after expenses and costs, long term investors have done well. There were disaster years, of course, like 1974 when UK equities fell by 44%, but they recovered handsomely in due course.
By contrast, cash returned only 0.46% per year after inflation over this 119-year period. The cost of safety and security was returns one tenth of those of equity investors.
For long term investors, then, cash is an expensive luxury. Most people would be better off holding as little cash as possible and buying a chunk of equities instead.