Holding cash can be riskier than equity investments

INVESTORS are increasingly concerned about market risks because of factors such as Singapore’s elevated core inflation, propelled by aftershocks of Covid-19 and the geopolitical conflict between Russia and Ukraine. According to an Endowus report, inflation is currently the greatest financial concern among Singaporeans, and up to 69 per cent feel growing pressure to save more.

In this climate of high inflation, strategies to maximise money growth are no longer a luxury but a necessity. As a result, many investors are reluctant to invest in the market, and some even sell their stocks and bonds to minimise losses. In response, banks offer higher deposit rates to appeal to investors who choose to hold money in the form of term deposits.

Cash is king, or is it?

Holding cash may seem like a safer option during market volatility, especially with the emotional comfort of knowing how much one has at any given time. However, this is not ideal as it remains vulnerable to inflation, especially in the current macroeconomic environment. Inflation erodes the purchasing power of cash and the value diminishes, meaning the goods and services one can buy in the future will be less than what can be bought today.

Here is a simple calculation illustrating the risk of holding cash versus stocks. Between 2011 and 2021, the return on cash (as measured by the annualised return of the three-month US Treasury bill) was 0.47 per cent. If we adjust for inflation, which was 2.17 per cent on average during those 10 years, the return was minus 1.7 per cent. Put simply, if you held US$100,000 in Treasury bills in 2011, you would have had US$84,243.26 of buying power 10 years later.

Conversely, over the same 10-year period, a US$100,000 investment in the S&P/TSX Composite Dividend Index would have resulted in US$200,797.37 of buying power, thanks to its inflation-adjusted annualised return of 7.22 per cent.

In addition, investors should also consider how real interest rates, such as bank deposit rates minus inflation, affect their returns. From January to February 2023, the annual nominal interest rate on three-month term deposits in most Asian countries or regions varied from 2.5 per cent to 5.4 per cent. However, when adjusted for changes in the consumer price index during the same period, the real three-month time deposit annual interest rate ranged from negative 5.2 per cent to 1.09 per cent.

Upgrading skills to upgrade your income

Another immediate thought during inflation is to invest in oneself, by allocating money towards upgrading skills and acquiring new qualifications to boost earning potential and enhance future career prospects. Government initiatives, like SkillsFuture, provide Singaporeans with opportunities for lifelong learning skills to advance their careers and potentially lead to a higher income.

However, this option requires time, effort and an already present amount of financial resources, and may only be feasible for some. Furthermore, education and skill enhancement do not guarantee immediate returns, leaving some questioning whether the cost and effort will be worth the rewards.

Making cash grow

Despite the seemingly pessimistic perspectives on retaining cash and upskilling, there is a silver lining, as alternative methods exist to increase wealth. Diversification – splitting your money across a range of assets like stocks, bonds, and real estate – could be your key to unlocking long-term wealth expansion.

Historical data has shown that investments in these assets have the potential to outpace inflation over time. From 2009 to 2022, compounded annual nominal returns for Asian equities and bonds were 8.15 per cent and 4.38 per cent, respectively. Real estate investment trusts in the Asia-Pacific region generated an annualised return as high as 11.38 per cent. One of the main advantages of these investments is that professionals manage the risks and volatility of the market on behalf of investors, who can benefit from cost averaging and risk diversification.

That is not to say that holding cash always leaves us at a disadvantage. There is a time and place for retaining a certain amount of cash, particularly for immediate expenses or short-term financial needs. Yet if cash is destined for future spending, it should be invested accordingly. Storing away cash for long periods is similar to voluntarily reducing one’s monthly savings or agreeing to lower one’s salary each year.

In navigating inflation’s choppy waters, diversification stands as a beacon of hope. A sudden decline in one asset can be cushioned by the performance of others, adding a layer of financial security.

The bottom line? Balancing short-term cash necessities with strategic long-term investments is the secret recipe for a robust financial future. By allowing money to “diversify” and multiply, one can ride out the inflation wave and secure a healthy and sound financial future.

The writer is head of retail wealth distribution and head of direct digital business and portfolio, Asia, Manulife Investment Management