We delude ourselves in all kinds of ways about how safe our investments are, but one that really stands out is thinking it's safe to hold lots of cash.
Investors put too much faith in dividend stocks, bonds and real estate these days, but at least there are naysayers around to raise questions and spark a debate. Cash, an asset class Canadians happen to love more than people in many other countries around the world, gets a pass for some reason.
Let's fix that. In your personal balance sheet, cash can be trash. Keeping a separate emergency fund in cash makes good sense, and cash is your smart choice for building the down payment on a house you expect to buy within five years. But if a pie chart representing your portfolio were to show a big wedge in cash, you may quietly be subverting your own best interest.
The global investment firm BlackRock issued its 2014 Investor Pulse survey this week and the findings show that Canadians, on average, believe that 27 per cent of their wealth should be in cash. But, as is so often the case in personal finance and investing, the difference between what people say and actually do is big. The survey shows that two-thirds of savings and investments in Canada are held in cash, compared to the global average of 59 per cent.
Could it be that Canadians have lost sight of the differences between saving and investing? Noel Archard, head of BlackRock's Canadian arm, describes today's preference for cash as an inversion of the uber-aggressive stance that was seen in the bull market run of the late 1990s.
"In the late '90s, we had people confusing investing for saving, and speculation for investing," Mr. Archard said. "Today, I feel like people have gone to the other side of the spectrum, where they're confusing saving with investing."
Asked for the rationale behind their cash holdings, 43 per cent of Canadian participants in the BlackRock survey said they want flexibility and 40 per cent said they wanted to feel safe. Again, flexibility is desirable if you're planning a short-term purchase, say a house, car or big vacation. But anyone who equates flexibility with being able to exploit a market decline to buy stocks at low prices is dreaming.
The difficulty of timing the market was apparent in the stock market decline earlier this month. Just as investors began waking up to a plunging market, stocks stopped falling and began to recover. The sorry truth about hoarding cash to exploit a market decline is you may well be too scared to buy when the price is right.
It's the idea of cash being safe that really demands some critical thinking. There's no question that cash is a zero-drama choice. Treasury bills issued by the federal government have virtually no risk of defaulting because they're backed by an entity with a triple-A credit rating and the ability to raise taxes as a last resort to meet debt obligations. Term deposits and high interest accounts at retail banks are guaranteed for up to $100,000 by Canada Deposit Insurance Corp., and some provincial credit union deposit insurance plans have unlimited ceilings.
But one of investing's primary rules is that safe investments produce low returns. That's why a high interest savings account will get you no more than 1.3 to 1.95 per cent at online banks and credit unions. Investment savings accounts (they're savings accounts for your investment portfolio that are bought and sold like mutual funds) yield 1.25 per cent for the most part.
With inflation running at 2 per cent, cash is actually losing you money after cost-of-living increases are considered. A bigger problem is that your cash holdings probably aren't growing enough to help you reach your long-term financial goals, specifically a comfortable retirement.
In a Portfolio Strategy column from earlier this month, 11 portfolio managers and investment strategists issued the best estimates of how a balanced portfolio would perform on average over the next 10 years (read it online at tgam.ca/EFlP). Most projections were in the 4- to 6-per-cent range.
If you invested $5,000 annually for 25 years and earned an average 4 per cent after fees, you'd end up with a little more than $216,500. At 1.25 per cent, you end up with just about $147,500. Mr. Archard said there are two implications of this kind of shortfall: You either work longer, or cope with a lower income in retirement. Another option is to save more, but you may be surprised at just how much more might be required.
If you were to rely on cash earning 1.25 per cent to achieve your financial goals, you'd need to contribute $7,340 annually to end up with $216,500 at the end of 25 years. That means increasing those $5,000 annual contributions by almost 50 per cent.
BlackRock's survey results show that investors aged 25 to 34 hold the most cash of any age group, with 69 per cent of their assets in cash. Mr. Archard said young people may be saving money for houses, so their high cash holdings are to some extent sensible. But he also thinks that today's young adults may have been turned off of traditional investing by the volatility of the past five or six years.
"I think we have a generation that is a little bit uneasy with deploying their money into investments," he said. "It's hard to have a historical perspective when everyone keeps telling you it's going to be different this time."
Mr. Archard doesn't think it is different, which is why he believes people overloaded with cash should decide if they're savers or investors, and act accordingly. He suggests investors move promptly to move cash into a diversified portfolio, but concedes that a gradual approach may work best for those who fear a stock market decline.
Asked in the BlackRock survey about their future plans regarding cash, 82 per cent of participants said they planned to add more or keep what they have and the rest said they'd take money out or weren't sure. In cash-crazy Canada, reversing those numbers would be progress.
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