Last month, I met two high net worth (HNW) individuals who were holding an unusually sizable portion of cash in their portfolios for two very different reasons.
The first investor (let’s call him Ronald) was an elderly patriarch of a family real-estate business. He still held a handful of income-generating properties, but almost everything else was in cash.
Ronald had started building his cash allocation several years ago, exiting his equity investments in the wake of the 2008 financial crisis. He largely saw cash as a refuge from volatility, as many other investors did. Yet, even several years after the 2008 downturn, Ronald still had very little confidence in most every asset class, no matter where in the world. He sees nothing on the horizon that would change that opinion – just the opposite.
The second investor (let’s call him Bill) was in his mid-fifties. He had sold his services business in the oil patch about three years ago. He had used some of the proceeds to achieve some personal financial goals – he had built a new home; he had purchased new cars for himself and his wife; he now had an attractive vacation property in Hawaii; that kind of thing.
But almost three years after the sale, the bulk of the proceeds were still in cash, largely because Bill was unclear what he should do with it. Everything seemed very volatile, cash appeared to be the best choice. So much so, that he had largely stopped looking for opportunities altogether.
Now, these individuals both had valid reasons for holding cash (and in Ronald’s case, part of that reason was his age). But what wasn’t valid was the length of time they had been holding it. To be blunt, both of them were stuck in a kind of “cash paralysis.” They had gotten used to the certainty of cash, without thinking about the cost of that certainty over time.
I find this is a trap many investors can fall in to – HNW and otherwise. Many people think of cash as a place to weather the storm, or as a parking place as they wait to buy securities in a correction. It can be. But too many people ignore inflation, taxes and historically low interest rates – all of which can make savings accounts and short-term money market holdings an extraordinarily unappealing place to hold a significant portion of your assets over the long term.
Consider this chart I came across the other day. I realize it uses U.S. data, but the Canadian experience wouldn’t be all that different. In fact, I have a hunch it would prove the point even more, because taxes historically are generally a bit higher here.
As a professional advisor (and investor), I’ve always known cash offers the least attractive returns of the asset classes. But I was shocked to see how unattractive it actually was. In actual fact, over the very long term, you’re losing money. To me, this begs the question: where’s the real risk? In stocks or in cash?
Now, don’t get me wrong, there are legitimate reasons to hold cash:
You have expenses or a financial commitment coming up in the short term
Say you want to buy a house, or pay for a child’s (or grandchild’s) tuition, or take a trip around the world. When the expenses are certain, your source of funds needs to be certain as well. Cash fits the bill here.
You’re researching other opportunities
Maybe you’ve determined the market as a whole is too expensive. Maybe you think certain assets aren’t compensating you fairly for the risk you’re taking. Or, perhaps you need more time to complete your research or due diligence. This kind of short term tactical hedge is tailor-made for cash. Warren Buffett calls this process “hunting for elephants.” The bullet in his elephant gun is – you guessed it – cash.
You’ve had a liquidity event, and you’re taking a “time out” before deciding on a long-term financial strategy
Perhaps you sold your business or your commercial property, maybe you received a large inheritance or settlement. Cash is a perfectly legitimate short term “parking place” while determining your next move, particularly for those getting used to changing financial circumstances.
You have a business or investment that requires a certain amount of cash on an ongoing basis
People who have a rental property know this problem: there’s always something to repair or improve, expenses to pay, etc. Call it the cost of doing business. Warren Buffett has this problem too. Most of his investments generate attractive cash flow, but some (his railroads and power generation businesses, for example) require a lot of cash in order to do it.
But beyond these reasons, cash isn’t a viable long-term portfolio allocation – it’s simply too expensive. We don’t usually think of it that way, but make no mistake, that’s what it comes down to. Hold cash for too long, and you could be sacrificing your long-term financial health.
Thane Stenner is founder of Stenner Investment Partners within Richardson GMP Ltd., as well as Portfolio Manager and Director, Wealth Management. Thane is also Managing Director for TIGER 21 Canada (www.tiger21.com/canada). He is the bestselling author of ´True Wealth: an expert guide for high-net-worth individuals (and their advisors)’. (www.stennerinvestmentpartners.com) (Thane.Stenner@RichardsonGMP.com). The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. Richardson GMP Limited, Member Canadian Investor Protection Fund.