By Francis Marais and Jan Vlok, 7 September 2017
Of course, when investment horizons are short term in nature, low-risk investments, such as cash or money market are fundamentally warranted, although better opportunities exist. However, when individuals invest for long-term real growth, it is important not to place too much emphasis on short-term movements. By definition, the investment is for the long term. Unfortunately, it takes time for individuals to see why they needed to persevere, but this usually only becomes clear after the fact. Hindsight is 20/20 vision.
For some investors, education could be a tool to mitigate bad investment decisions. For instance, long-term investors could be informed of the disadvantages of cash (see below), and consequently their minds could be changed. However, some individuals exhibit emotional biases despite information and education efforts.
Although there are some benefits highlighted above, the fact of the matter is that there are unit trust funds and collective investment schemes available to investors which offer many of the same benefits, but without having to give up the opportunity to achieve real returns for these individuals. For instance, the South African Multi-Asset Income funds provide similar benefits through:
In summary, cash does offer some benefits, including downside protection, as no volatility or drawdowns are experienced. It also offers optionality or trigger-pulling ability when risky asset prices are attractive. However, as in the case of fixed deposits, an investor would have to pay excessive penalties on an early withdrawal. Cash investment is not an advantage: it has portfolio construction benefits as the asset class exhibits low correlation to other classes. It is only beneficial when used in a portfolio of different asset classes and not as a standalone investment. The reason why people have preferred cash as an investment destination recently, is that it offers emotional well-being.
The disadvantages are manifold and pronounced. A cash investment would ensure poor long-term real returns (if any), and necessitates good timing decisions into and out of the market, as in the case of risky assets. It would have dire consequences on total return if just a few good trading days on the Exchange were missed. It would need prolonged fixed periods, which gives rise to opportunity cost, illiquidity and penalties. Finally, the impact of tax makes a cash investment very unattractive, especially when an investor is taxed on the maximum bracket and when exemptions are exhausted.
Although there are a few benefits of cash, these benefits can be extracted through investment in a low-risk unit trust fund or collective investment schemes vehicles and funds in the SA Multi-Asset Income Category are good, viable examples of this. Investors will experience most of the benefits, without having to give up the opportunity of real returns. For investors exhibiting errors in judgement in relation to their investment decisions, i.e. flawed decision-making due to a lack of education or understanding, information dissemination and education could solve the problem. However, for individuals exhibiting emotional biases, education will not mitigate the issue successfully. In conclusion, there should be emphasis placed on viable alternatives to cash, which will not compromise the individual’s investment portfolio to the degree that a cash investment or fixed deposit could.