Is cash a good asset class alternative?

In the second episode of season two of the Unpacking Wealth Creation podcast, Investec Wealth & Investment’s Browen Trower (fund analyst) and Glen Copans (senior portfolio manager) look at cash as an asset class, what risks are associated with it and how your levels of cash should change as you grow older.

What do we mean we talk about cash as an asset class?

Copans explains: “The simplest form of cash is cash in hand: notes and coins that are used to pay for goods and services. In the investment sense, cash is equivalent to a low-risk investment  because it is liquid and it’s relatively predictable. For example, if you’ve opened up a three-month fixed deposit account, you know what interest rate you’re going to get and you can figure out how much your initial investment will be worth in three months’ time. 

“It’s viewed as the ‘risk-free’ component of an investment portfolio for these reasons, but that’s not to say all cash is risk-free because different cash products will have different risk profiles. Cash in hand is more liquid than a three-month fixed deposit account because with the latter, you have to wait three months until you can access and use the cash. So, when you pick which cash option to go for, you have to make sure you’re happy with its risk profile.”

What does ‘liquid’ mean?

Liquidity is the ability to access and use your money quickly. Cash is generally considered a liquid asset class, but can also be illiquid if, for example, you put your money away in a savings account that doesn’t allow you to access it for a period of time. 

What are the main risks associated with cash?

“Cash doesn’t always ‘beat’ inflation. In other words, inflation can erode the value of cash. If prices are rising at a faster rate than your cash is earning interest, your investment will be worth less in the future," explains Trower. "To beat inflation, you may have to move higher up the risk spectrum, into fixed income or even equities. But growing faster than inflation is not always the ultimate goal for this asset class – it’s often liquidity and capital preservation.”

What is inflation?

Inflation is a general rise in prices in an economy.

What are the main things I should consider when investing in cash?

“As with all investments, you need to consider your risk profile, which is often based on your life stage," says Copans. "This will determine how you construct your portfolio: how much you allocate to cash or to higher risk investments. For example, if you’re a conservative investor that doesn’t want volatility then you probably want to hold higher levels of cash. Higher levels of cash can also be useful in times of higher uncertainty because you can deploy it quickly into opportunities that may be mispriced because of that market volatility.”

Trower adds: “There are three reasons to hold cash as a young person: to support a lifestyle, to pay for a life event, or to protect against adversity. In terms of supporting a lifestyle: you may hold cash in order to go on holiday, or to create a buffer if you want to change jobs. Life events can include paying for an engagement ring, funding a lobola payment, your wedding or buying a big present for a milestone birthday. In terms of the adversity element, this is really a rainy day fund so that you have cash available should your geyser burst, you have to replace a car tyre or you need to pay an insurance excess because of an accident of some sort."      

Copans continues: “While everyone’s needs will be different in each life stage, it’s generally the case that when you’re young, you tend to be in the accumulation phase of your life where you are building your wealth. Because you hopefully have a long life ahead of you, you’re able to take on higher risk investments with the goal of generating good returns over time. While you still need some cash from a liquidity perspective, it shouldn’t be as much as when you’re heading for retirement and have liabilities you need to meet. You want to be de-risking the older you get because your liquidity needs are likely to be greater than when you were young.

“Cash tends to be quite penal from a tax perspective compared to equities. So if you are a higher rate tax payer you need to consider quite carefully how much cash you need to have on hand. It could be that you rather invest your money into something with similar characteristics to cash – so a low-risk, low volatility investment that can preserve your capital at the same time.”

What does a rising interest rate environment mean for my cash?

“In an uncertain world and as rates are rising, risk assets such as equities can be quite volatile. For people that want to avoid this, and have a shorter term investment horizon, cash-type investments are likely to prove more appropriate," says Copans.

“Increasing rates put us under pressure in some ways because we face higher payments on our debt, but they can also help you earn a return that’s greater than inflation and protect your cash," adds Trower.