Cash is not king

Prudence doesn’t pay and cash is not king … take those two messages to heart and investor-savers may emerge from 2013 with their wealth intact despite market conditions that remain extremely challenging.

This market insight comes from numerous fund manager that are concerned that retirees are losing out to low interest rates, rising inflation and the taxation effects on ‘safe’ income investments.
The wealth of many middle class South Africans is being depleted slowly but surely and one reason is that in uncertain times many savers and investors believe prudence pays. They therefore put money into fixed deposits, savings accounts and perhaps the money market.

In fact, prudence on this pattern has not paid for several years now. So-called risk assets – that means equities – have a much better track record of protecting retail investors from the effects of inflation and taxation.

Cash is not king because with inflation at over 6% and maximum marginal tax on income at 40%, many people earning interest on cash holdings actually lose out.

Cash investment is only safe in the sense that the capital is not at risk. You will get your principal back. But the money won’t buy as much.

What most people need is an inflation-beating return of more than 6%. To cancel out the effects of taxation, a return of 10% or more would be even better. This is highly unlikely unless the individual’s portfolio contains an equity component.

Figures from the collective investment industry indicate that growing numbers of largely conservative unit trust investors now commit to balanced and managed funds – instruments with exposure to equity markets. However, many conservative investors still believe equities entail risk and they should avoid them altogether. Our worry is that many savers and investors over the age of 60 maintain a traditional belief that ‘cash is king’ when excessive cash holdings simply erode their wealth in the long haul.

It is necessary to challenge the belief in the big cash stash or the fixation with fixed deposits. Equities carry a short-term risk of loss. However, cash carries the long-term certainty of loss of real value/ purchasing power. But if you have a medium investment horizon and no immediate need for all the cash, equities are not nearly as risky as their categorization as a ‘risk-asset’ suggests and in fact are necessary to avoid erosion of capital.