Why Cash can be the Riskiest Asset of All

by | Dec 1, 2018

Every investor would have heard of equity and listed property referred to as ‘risk assets’. They would also have seen a graph which shows the relative risk of different asset classes, with cash at the bottom as the ‘lowest risk’ and equity at the top as ‘highest risk’.

Intuitively, this also makes sense. Cash in a bank is pretty safe, and to a certain extent is even guaranteed by the Reserve bank. Unless there is a serious meltdown, you’re unlikely to lose it.

Shares, on the other hand, are a lot less secure. Anyone who was invested in the stock market at the time of the 2008 crash can attest to that. The FTSE/JSE All Share Index fell over 40% from its high in May that year to its lowest point in November. Recently, the same index fell by 15.5% in September/October 2018 (see graph below).

However, there is a major caveat to this that easily gets overlooked, and often to an investor’s detriment. When people talk about risk in this context, they are talking about volatility in asset prices and the potential for a short-term loss of capital.

That’s certainly appropriate if you are putting money aside that you might need in the next year or two, but it’s far less so when you’re investing over the longer term. When your investment horizon extends over ten or 20 years or longer, there’s a far more serious risk to your wealth than the day-to-day ups and downs of asset prices.

The biggest risk faced by investors is that of inflation. Inflation is often only noticed when it’s too late as it quietly and slowly consumes the spending power of your hard-earned money and investment returns.

Many people don’t realise just how much inflation eats away at wealth over time. The graph below illustrates how the value of R10 000 decreases over a 30-year time period at different inflation rates.

Source: Old Mutual Investment Group, MacroSolutions

What this shows is that even at an inflation rate of just 3%, the value of R10 000 would diminish to the equivalent of R4 000 in 30 years. At the upper end of the South African Reserve Bank’s target range, that R10 000 reduces in value to the equivalent of just R1 700 in today’s money over the same period.

While these values are used as examples, based on the CPI figures reported in the news, we understand if you experience a higher rate of inflation due to rising education or medical costs for example, it has an even larger impact. At 9% inflation, your R10 000 today is worth only R750 in 30-years’ time. It’s fair to say that inflation is a long-term investors true nemesis, and it’s a relatively silent one at that.

Given this reality, the perceived safety of cash takes on a very different complexion. This is because while your money in the bank might never decrease, it is not going to increase much in real terms either.

Old Mutual have analysed the same data we have used with Morningstar to get a long-term experience that investors would have had in various asset classes – the results are indisputable. The return from cash in South Africa over the last 88 years has been 6.9%, compared to inflation of 6.2%. That is before tax. Therefore, cash in the long term is not the answer.

To combat inflation, what investors need is exposure to higher growth assets such as equities and listed property. As the graph below shows, over the same 88-year period local equities have produced real returns of 7.8% per year on average.

Source: Old Mutual Investment Group, MacroSolutions

One of the biggest job for advisors is to get this message across to investors because one of the problems with these growth assets is that they are often termed risk assets because they display volatility. At the end of the day, most investors are looking for a smooth ride to retirement, unfortunately this is not always the case. But at the end of the day, volatility is not the biggest risk that long-term savers face. It is inflation. Volatility may be uncomfortable and from time to time as equities do fall in value, and if you have a short-term time horizon that can be problematic. But even in retirement most investors still have a multi-decade time horizon and need exposure to assets that will grow ahead of inflation.

What makes this argument even more compelling is that the longer you stay invested, the less volatility plays a role. In fact, over the last 58 years, holding equities for more than five years in South Africa has never been a risky strategy.

Source: Old Mutual Investment Group, MacroSolutions

What history shows us is that in the very short term of a day or a week – even a quarter or 1-year period – the chance that you could have lost money by holding local equities has been extremely high. As we extend our buy and hold period to years, that chance of losing money decreases rapidly. Over the last 58 years, South African investors would never have experienced a negative 5- or 10-year investment period had they been in equities. Along the way there would have been periods of volatility, but these figures show that if you adopt a long-term investment strategy, no matter what happens during that period (like what we have been recently experiencing), the best investment decision you can make is to do nothing!

Time, in other words, has the effect of smoothing returns.

The direction the market takes in the short term is almost equivalent to a coin toss. The factors driving markets in the short term are noise and sentiment (elections campaigning, state capture, or just about any market headline you read nowadays). However, over the long-term, fundamentals and starting valuations play a for more important role.

We can not reiterate this enough. We are fully aware that our markets are going through and have been going through a tough time for some time now, but we are confident and resolute in our approach to investment management. If you invest through Resolute Wealth, you can be confident in the fact that you are invested with the biggest and the best funds available who have years of experience in managing money during all economic cycles. Trust the decisions you have made with your advisor and let time smooth out the journey.