Is cash always king? (The Retiree)
- Cash is king when investing for short time periods
- Over the long term cash struggles to hold its purchasing power due to inflation
- Allocating a meaningful portion of your super to shares can make sense
This article was originally published for The Retiree.
‘Cash is king’ the saying goes, but not always for the conservative investor.
Investing in shares can be daunting for many people. Some think it’s gambling, others simply can’t stomach the unpredictable price movements. But even if you’re a conservative investor, allocating a meaningful portion of your super or investment portfolio to shares – both Australian and international – can make sense.
The timeframe over which you’re investing is a very important consideration. If you’re investing money you need to spend within the next few years, cash (in the form of a bank account or term deposit) is king. The beauty of cash is that – barring financial disaster – you know you’ll receive back your initial investment plus a little bit of interest.
In the short-term, the price of other investments like shares tends to bounce around from one day to the next. If you need to spend the funds a year from now, investing in shares presents the risk that they are suffering a temporary downturn in price when you need to sell them.
Price volatilityVolatility measures the rate of change of an asset’s price and is a term usually associated with shares. The higher the rate of volatility, the more a share price ‘bounces around’ in the short term. is not limited to shares - property can also be a tough short-term proposition. Not only is there the price to worry about, but you also need to cover the large upfront transaction costs you incur (for example, stamp duty) and back-end commissions to your agent.
Over the long-term – especially decades or more – things become very different. Cash struggles to hold its purchasing power due to inflationThe gradual decline in the purchasing power of money over time. Alternatively, the general rate at which prices increase over time. In Australia inflation is typically measure by the Consumer Price Index (CPI). – the tendency of prices to increase over time. This means that $1 buys you less in the future than it does today. The only certainty you’ll get from holding all your savings in cash for a decade is that your savings will buy you roughly what they could have bought today, or probably less.
While volatileVolatility measures the rate of change of an asset’s price and is a term usually associated with shares. The higher the rate of volatility, the more a share price ‘bounces around’ in the short term. A share or asset with a high rate of volatility is said to be 'volatile'. in the short-term, shares aren’t as volatileVolatility measures the rate of change of an asset’s price and is a term usually associated with shares. The higher the rate of volatility, the more a share price ‘bounces around’ in the short term. A share or asset with a high rate of volatility is said to be 'volatile'. when viewed over much longer time frames. Chart 1 shows the price movements in value of the overall Australian and US share markets over the last 30 years.
There are two key points to note. Firstly, the chart ignores dividends; overall returns to share investors would have been far greater than the 8.4% and 5.7% compound annual growth shown here. Secondly, I’ve used quinquennial (five year) prices, rather than the daily or monthly pricing normally displayed in share market charts.
The chart clearly shows that despite several financial crises, starting with the 1987 share market crash, share markets have tended to rise over longer periods of time. Those invested in cash over this period would have fared much worse.
That’s not to say there won’t be ups and downs or that you can’t lose money investing in shares. For instance, buying hot stocks in a booming market – like the now defunct ABC Learning which grew earnings rapidly by taking on lots of debt – can quickly lose you a lot of money.
We’re also not suggesting conservative investors allocate all their money to the share market. There are good reasons for investors, especially retirees who need certainty of income, to hold some of their portfolios in bonds, term deposits and bank accounts.
But if you’re investing all your money into cash because investing in shares seems too much of a gamble, history shows that you’re probably going to lose out. When done sensibly and viewed through a long-term lens, investing in shares hasn’t been a gamble, but a proven strategy for wealth creation.
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