Investors should put any excess cash to work
Inflation expectations and government bond yields have been moving higher in recent weeks, suggesting greater optimism over the economic recovery. But central banks have made it clear that policy rates are set to stay on hold, even as inflation rises. That means real returns on bank deposits will likely stay negative, making cash holdings a drag on portfolio performance. We recommend investors reconsider the levels of cash they hold and put any excess cash to work.
Too much cash is costly in a world of negative real rates.
• Real rates are set to remain negative in much of the world in the coming years.
• Take the example of an investor with a USD 5mn portfolio and annual expenses of USD 250,000 that are rising by 2% each year due to inflation.
• Keeping the portfolio in cash and drawing down to meet expenses would halve its value in just 10 years.
While investors need to keep cash for upcoming spending needs, many hold too much in bank deposits.
• The seven biggest pension fund nations globally, which had total assets over USD 42.8tr in 2019, have an average of just 4% cash exposure, while holding around 45% in equities.
• Although private investors may need more than this, especially as they near or enter retirement, we believe many hold too much cash.
• Our Investor Watch Survey for 4Q20 showed the average client holds 25% of their wealth in cash and cash equivalents.
Having set aside enough liquidity, investors are freer to focus on finding yield and growth opportunities.
• We believe investors should limit liquidity to three to five years of spending needs that can’t be met by income.
• While near-term liquidity should be held in cash, investors can consider taking more risk for higher returns for funds set aside for more distant spending needs.
• For the rest of a portfolio, investors should put funds to work in risk assets. For yield, we see opportunities in riskier credit segments, such as
Asian high yield. Meanwhile, equities are the main driver of growth in most portfolios.
Did you know?
• We believe investors should consider their liquidity strategy in three main tiers: tier 1 for everyday cash needs in the next 6–12 months; tier 2 as savings cash for known needs over the next 2 years; and tier 3 as investment cash for potential investment opportunities over the next 2 to 5 For tier 3 cash, we believe investors can consider taking credit or counterparty risk in order to earn higher returns, for instance by investing in shortterm corporate bonds.
• The average annual return on the MSCI All Country World Index since 1998 has been 8% (USD total return), meaning investors over this period have doubled their money roughly every 10 years.
Investment view
Holding excess cash carries a significant opportunity cost and is likely to deliver negative real returns long-term. So we think investors should take exposure to equities and higher yielding bonds to enhance potential returns.