The Garrulous Jay – Cash Trapped

Question – when is/was the more attractive time to leave funds on deposit: (a) today when the bank might give you 5%, or (b) eight years a go when you probably would have received about 0%? Answer – probably (b). Allow me to explain…

The first thing it’s important to be clear about is that cash is not an “investment”.

This is because, in my opinion, an investment must build wealth. In order to build wealth it must therefore deliver a return in excess of inflation over the medium to long-term.

If we take Consumer Prices Inflation for the purposes of answering my rhetorical question, it stood at 6.7% in August this year compared to 0% in August 2015 (source: ONS). In other words, your funds on deposit would effectively have been maintaining their purchasing power eights years ago, whereas today it is being eroded at a rate of 1.7% per annum.

Put simply, you are getting poorer more quickly today than you were in 2015, if you leave money in the bank. And yet I frequently find myself in meetings with clients who express a wish to leave funds on deposit rather than investing in the markets. Some have even been tempted to cash in their (‘real’) investments to put the proceeds in the bank.

Let me be clear on two things. Holding some cash to cover emergencies is essential. I would actually go further and say there is nothing wrong with holding significantly more cash than just an emergency fund if that fits with an individual’s risk appetite, as long as they understand this is not part of their investment portfolio.

I also understand the attractions of cash… Generally speaking, it’s ‘safe’ as your capital is not at risk. What’s more, after many years when the banks paid interest of almost nothing, and a period during which the returns on investments have been underwhelming, 5% looks pretty attractive.

The big risk, though, is you end up “cash trapped”. As with any financial decision, the easy bit is deciding when to put the money in: the harder part is knowing when to take it out.

When I speak to people tempted by the allure of cash they often claim they have a crystal ball. To be fair, that’s not quite how they put it, but they will say something like, “I’ll reinvest when things settle down and the markets are going up again”. They’ll almost certainly miss the boat.

After the Dotcom bubble burst stockmarkets reached their low point, as measured by the MSCI All Companies World Index (source: FE Analytics), on the 12th March 2003. Three months later they were up 22%. After the 2008 Financial Crisis the low was the 6th March 2009. Three months later the markets were up 28%.

No one called the bottom precisely. I know: I was sitting on a bank’s trading floor on both days!

The lessons to draw from this are clear. Keep in cash what makes you comfortable, but invest the rest. Don’t try to time it. Don’t get cash trapped.