Why cash is the riskiest asset
WEALTH RISKS: INFLATION IS A SILENT KILLER
Inflation is a long-term investor’s true nemesis – Graham Tucker
Most investors would have seen a graph showing the relative risk of different asset classes, with cash as “lowest risk” and equity as “highest risk”.
Cash in a bank is pretty safe, and to a certain extent even guaranteed by the SA Reserve Bank (Sarb). Shares, however, are a lot less secure.
However, there’s a major caveat to this that’s easily overlooked, often to an investor’s detriment. Risk in this context refers to volatility in asset prices and the potential for short-term loss of capital.
That’s appropriate if you’re saving money for the next year or two, but far less so when you’re investing long term. When your investment horizon extends over ten or 20 years plus, there’s a far more serious risk to your wealth.
“The main investor risk lies in inflation,” says Old Mutual Balanced Fund manager Graham Tucker. “Inflation quietly consumes the spending power of your hard-earned savings.”
He says many people don’t realise just how much inflation eats away at their wealth. Graph 1 illustrates how the value of R10 000 decreases over a 30-year period at different inflation rates.
Even at a 3% inflation rate, the value of R10 000 would diminish to the equivalent of R4 000 in 30 years. At the upper end of Sarb’s target range, that R10 000 reduces in value to the equivalent of just R1 700 in today’s money.
“At 9% inflation, your R10 000 today is worth only R750 in 30 years time.”
The perceived safety of cash now takes on a very different complexion: while your money in the bank might never decrease, it won’t increase much in real terms either.
“We’ve analysed the long-term experience of various asset classes and arrived at a few indisputable conclusions. 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, investors need exposure to higher-growth assets like equities and listed property. Over the same 88-year period local equities have produced real returns of 7.8% per year on average (see graph 2).
“One of the problems with these growth assets is that they are often termed ‘risk assets’ because they display volatility,” Tucker notes. “But volatility is not the risk that long-term savers face. It is inflation ... even in retirement most investors still have a multi-decade time horizon and need exposure to assets that will grow ahead of inflation.”
The longer you stay invested, the less volatility plays a role.
“In the very short term of a day or a week, the chance that you could have lost money by holding local equities has been extremely high,” explains Tucker. “But as we extend our buy and hold period to years, that chance of losing money decreases rapidly.”