Dangers of saving too much cash
We rarely hear any warnings about playing it safe. We don't see headlines that say: "Hoarding cash forces family to file for bankruptcy", or "Placing deposits wipes out retirement savings."
The only news we read about is how someone lost all his money investing in the Enrons, LionGolds or Hyfluxes of the world.
It's no wonder we all want to play it safe and hold cash. A BlackRock survey conducted in 2017 found that Singaporeans hold almost half (47%) of their savings in cash.
But the truth is, there are dangers to playing it safe. They just aren't as obvious or dramatic.
Cash rarely performs negatively (unless you're in a negative interest rate environment), but this doesn't mean that the value of cash will remain constant over time.
If your cash deposits are yielding about 1%, you're losing purchasing power every year due to inflation. Holding a sizeable portion of your portfolio in cash will cost you over the long term.
Investing is a long-term strategy
In his annual letter to shareholders in 2014, Warren Buffett explained how cash is actually a riskier investment than equities for the long-term investor.
During the five decades from 1964 to 2014, the S&P returned 11,196% including reinvested dividends. In the same timeframe, the purchasing power of a dollar declined by 87%, which meant that it took $1 to buy in 2014 what could be bought for 13 cents in 1965.
As Buffett says, for the majority of investors with multi-decade horizons, short-term market moves are unimportant. The "focus should remain on attaining significant gains in purchasing power over their investing lifetime."
Investing is a tool to help us reach our goals, and there is a target real rate of return our portfolios need to earn in order to achieve these goals. The higher the percentage of cash you hold in your portfolio, the greater the risk you need to take in your investments to hit that target rate of returns. With cash yielding close to zero, it is a significant drag on your overall portfolio returns.
If you start with $100,000 and want to double your money in 10 years, these are the returns you would need to achieve:
- 0% cash / 100% investments: 7.2% annualised returns on investments
- 20% cash / 80% investments: 9.6% annualised returns on investments
- 40% cash / 60% investments: 12.8% annualised returns on investments
- 60% cash / 40% investments: 17.5% annualised returns on investments
- 80% cash / 20% investments: 25.9% annualised returns on investments
The market gyrations may want to send you running to hide your cash under your mattress, but investing is a long-term strategy.
We don't know what will happen with the markets tomorrow, or the next month, or year. What we do know is that equities will almost certainly outperform cash over the next decade, and probably by a significant amount.
If risk is defined as permanent loss of capital, then we're not playing it safe by holding cash, we're just exposing ourselves to a different type of risk — inflation risk.
To get started with Endowus, click here.
Next on the Endowus Fin.Lit Academy
Read the next article in the curriculum: Are money market funds or high-interest savings accounts more suitable for you?
Investment involves risk. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. Past performance is not an indicator nor a guarantee of future performance. Rates of exchange may cause the value of investments to go up or down. Individual stock performance does not represent the return of a fund.
Any forward-looking statements, prediction, projection or forecast on the economy, stock market, bond market or economic trends of the markets contained in this material are subject to market influences and contingent upon matters outside the control of Endow.us Pte. Ltd (“Endowus”) and therefore may not be realised in the future. Further, any opinion or estimate is made on a general basis and subject to change without notice. In presenting the information above, none of Endowus Pte. Ltd., its affiliates, directors, employees, representatives or agents have given any consideration to, nor have made any investigation of the objective, financial situation or particular need of any user, reader, any specific person or group of persons. Therefore, no representation is made as to the completeness and adequacy of the information to make an informed decision. You should carefully consider (i) whether any investment views and products/ services are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You may also wish to seek financial advice through a financial advisor or the Endowus platform and independent legal, accounting, regulatory or tax advice, as appropriate.