Low return or a negative return - what's your pick?
13 Feb 2015
Recently the Reserve Bank of Australia (RBA) cut interest rates to a historic low of 2.25%. This is great news for those who have mortgages, loans or other debt as interest charges are further reduced. However, if you're at the other end of the spectrum and don't have any debt and also have your funds invested in cash, the downside of low interest rates is that you'll be receiving very little in interest payments on your savings.
Naturally in this environment, people are often more inclined to invest their savings in investments which can offer better returns ie, moving from interest bearing securities such as cash, to riskier investments such as shares and equities.
So is cash still king?
It's important to understand that cash does have its place in an investment portfolio and it may not, therefore, be appropriate for you to invest these funds into riskier style investments. If you're trying to decide whether cash is still king you might like to consider the following points:
(i) Negative return or a low return
A negative return (loss of capital) is far worse than a low return. If you do experience a negative return how will this impact your lifestyle? Think of those who have put money into investments that have blown up or are now frozen, they would ultimately have been better off in "cash". Most people have heard of the risk/return relationship; however still choose to believe that it won't happen to them. Just remember that negative returns do happen – can you afford to take the risk?
(ii) Access to your money
If you need access to your funds in the short-term, ie within the next five years, it may not be appropriate to have your money invested in shares and equities. You don't want to find yourself in a position where you need to access your funds and have to sell at a point where equities are valued at less than you originally paid. In this scenario you will effectively realize your losses as you don't have the time to wait for share prices to recover.
(iii) Consider your risk
Within an investment portfolio the cash portion of your investment is generally used to fund cash flow requirements and meet financial obligations ie, pension payments, bills, unforeseen expenses, etc. However, investing in cash does more than this – it also offsets the risk that people take in other areas of their portfolio such as shares and equities. If you were to remove or reduce your cash exposure you are in effect increasing the overall risk to your portfolio which may result in an adverse outcome.
(iv) Choosing your investments
Before investing a single dollar make sure you understand the in's and out's of the investments you're choosing to avoid making costly mistakes. It sounds easy but this can be a very complicated process as there are thousands of investments you can choose from. Don't leave your investment decisions to "luck" or a hint that you received at a BBQ over the weekend.
(v) Know your goals
Is building wealth important to you or are you more concerned with wealth preservation? If you currently have enough money to achieve the things that are important to you, why do you need to achieve a higher return in the cash portion of your portfolio? It may be that you just want to get the best bang for your buck, or perhaps you'd like to leave more behind as an inheritance. There is no right or wrong answer – it all depends on what your overall goal is. If you do chase the higher return and take on more risk because a) you can afford to do so and/or b) you want more money, you need to think about the potential flip side and how any losses on your investments will impact your desired lifestyle.
So, what's right for you?
When you consider all of the above points, it may well be that you have too much invested in cash and not enough exposure to higher growth assets. Before you decide make sure you revisit your financial plan – is it still achieving the desired outcome for now, the medium and the longer term? If you're not sure, then before you do anything else, speak with a professional financial adviser who can assist you in making informed decisions about what is right for you. Making the wrong choice can have a serious impact on your savings, so take the time to get the advice you need to achieve the lifestyle you want not just for today but also for the future.