The Flight to Safety: Is Cash Really King?
Many media commentators are speculating that the best way to weather the current stock market volatility is to stick to so-called “safe” investments such as cash and term deposits.
Thinking long term can be hard given the media focus on negative events. But investing isn’t just about the good times and the double-digit returns. Investing successfully for the long term also involves taking sensible stewardship of your portfolio during uncertain economic times.
It is important to note that there will always be occasions when switching to cash—or keeping a high portion of your investible assets in cash—may prove to be appropriate for some investors.
That said, most successful long-term investors do tend to stay invested during times like this. Switching to cash and cash-like investments right now may appear to be a tempting way to preserve your investment capital but it rarely stacks up as a sound long-term investment proposition for most investors. Why?
- Cash is historically a poor hedge against inflation in a falling economic market because headline interest rates usually fall at these times. After adjusting for inflation, the real interest rate that your cash or term deposit investment receives can be negligible or even negative. Inflation is a curse for investors looking to invest for a sound financial future as it effectively erodes the purchasing power of your investment over time. In a practical sense, it means that in the future $1,000 will buy less than what it does right now.
- Share investment income can be tax effective. Australian share investments often pay an income stream to investors (ie. a “dividend”), and this often has associated tax benefits (“franking credits” or “imputation credits”). Receiving a fully or partially franked dividend means that the company has paid company tax and you receive these franking credits as a tax offset. Whether you own shares directly or through a managed fund, the dividends and attached imputation credits will still flow through to you.
- Alternatively, investing in cash or term deposits will mean that your income stream does not receive any tax offsets, and in fact, will usually be wholly taxable. While this may be acceptable for part of your portfolio some of the time, it is seldom the best long-term option for the majority of your portfolio.
- Timing is everything. A timing decision is usually involved when you decide to liquidate share-based investments and keep the proceeds in cash, with the aim being to reinvest in the market when it is trending upwards. Experts all agree that choosing the right time to enact this strategy is an impossible task and that it is a much better idea to focus on your long-term financial strategy, rather than seeking cash or cash-like investments as a perceived safe haven. Switching out of growth investments also means you may miss out on the gains that occur when markets inevitably rebound. Rather than leaving your investments to chance, it’s much better to stick with quality investments—through the good and the bad times.
It’s an opportunity lost. If you have formulated a sound investment strategy and have invested in quality assets, selling these investments due to a broader market fall is a lost opportunity. It’s as simple as that.
There are definite investment considerations associated with seeking a safe haven in cash-like investments, so it is important to seek advice when considering changes to your investment strategy.