The insidious risk in holding on to cash

Business Times

2 days ago

[SINGAPORE] Cash is king – or is it? With interest rates still well above pre-2022's zilch and pundits touting the Singapore dollar's 'safe haven features', many are boosting cash holdings. But when does enough become too much?
Many investors carry high cash allocations because it feels safe – there is no short-term volatility. But an insidious risk lurks: Cash hampers long-term returns, risking a brutal, underfunded retirement or aged poverty.
Few investors fully consider this, but you should. Here's how and why to right-size your coffers.
Holding some cash, maybe six to 12 months' worth of expenses, is sensible. It's an emergency fund; it can help you invest better by avoiding forced securities sales at inopportune times. Or, if there is an upcoming, major expense in the next few years (think: home purchase), setting cash aside is likely wise.
Otherwise? Cap your cash.
Myriad studies show asset allocation – your mix of stocks, bonds, cash and other securities – determines most of your long-term return. Not market timing. Not stock picking. Not perceptions of 'safety'. Asset allocation is the keystone choice investors make.
BT in your inbox
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
Sign Up
Sign Up
Your goals, needs and time horizon – how long your assets must last to finance your goals – should largely determine your allocation. Generally, the longer your time horizon and more growth you need, the more you should have in high-returning stocks.
Maybe those taking cash flow or who can't stomach volatility hold some bonds. But cash, in most cases, should be quite minimal.
Why? Minimal returns. Since good data start about a half-century ago, the MSCI Singapore Index has annualised 8.3 per cent through 2024. Gold? 5.1 per cent. Ten-year Singaporean government bonds? 3.7 per cent. Cash? Short-term Singaporean government bills – a cash proxy – annualised the lowest, at just 1.7 per cent.
Inflation averages 2.6 per cent, which devours cash's return. If your goals require any growth, cash is highly unlikely to deliver it.
So, how much cash do you hold? What is your asset allocation? Too many investors don't know.
To size them up, start thinking in terms of asset class, not account or 'bucket'. Total all of your accounts – any brokerage account, savings or fixed deposits. Stocks, exchange-traded funds (ETFs), all of it. Put it all together.
Own funds that blend stocks and bonds? Dig into the weights. If you have S$100,000 in a 60 per cent stock, 40 per cent bond fund, chalk S$60,000 to stocks and S$40,000 to bonds.
Then subtract funds earmarked for known, near-term expenses or emergencies. Divide each category – stocks, bonds, cash and others – by the total. The resulting percentages are your allocation. What percentage is cash?
Conscious or not, your allocation may reveal an implied forecast. If you hold oodles of cash, you are saying history's lowest-returning asset class is more future-fit than historically higher-returning ones, such as stocks.
In other words, holding lots of cash is implicitly uber-bearish!
Is that intentional? If so, you need to see big negatives others don't – that markets haven't priced – to justify it. That is a huge risk – maybe the biggest one you possibly take if you need growth to finance your goals.
Many say they hold cash 'in case' stocks tumble. But what is the cost of all that cash? Usually those investors hold 'dry powder' long term, turning it into a comfy cushion.
Terrified, they don't take advantage of 'buy the dip opportunities' like early April offered. They ignore cash's performance, focusing on portfolio parts versus the whole, which is a dangerous mental error.
Big cash holdings feel good. But they hurt overall returns.
If you invested S$1,000,000 in 70 per cent Singapore-listed stocks and 30 per cent long-term Singaporean government bonds since 2000 – a cyclical stock market peak – your holdings would have grown to S$1,510,150.
Stash 20 per cent in cash, and you wound up with S$219,011 less. Cash is costly! And that is despite a big, multi-year bear market to start that stretch.
Sure, you may be thinking, that is over 25 years; surely shorter horizons bring loads more periods when stocks stink, no? Lost decades and such?
Not as much as you might think. Consider: MSCI Singapore data stretches back to 1969. Since then, using monthly returns, stocks were up in 62 per cent of rolling 12-month periods, through June. Not bad.
They have been positive in 82 per cent of rolling five-year periods – even better. Rolling 10-year periods? A whopping 99 per cent were positive! No rolling period greater than 11 years has been negative. None!
Moreover, while it is tough to beat inflation with cash, stocks can – and do. Singapore stocks averaged 53 per cent over those five-year rolling periods and 129 per cent over the rolling 10-year stretches. Similar patterns hold for global stocks.
The writer is the founder, executive chairman and co-chief investment officer of Fisher Investments, an independent investment adviser serving both individual and institutional investors globally