In Fisher Investments UK’s experience, sharp market swings drive many investors to seek the perceived safety of cash. We have seen other investors constantly carry a large cash cushion – likely far more than needed to fund their expected portfolio withdrawals or other expenditures. However, Fisher Investments UK thinks investors should scrutinise their cash holdings. Cash’s role in diversified portfolios targeting long-term growth is limited, in our view. Holding too much may be counterproductive and present risks investors should be cognisant of.
To be clear, Fisher Investments UK isn’t anti cash. An emergency cash reserve has its place in diversified portfolios, in Fisher Investments UK’s view, as investors then don’t have to sell other investments whenever an unexpected expense arises. Absent that reserve, carrying too little cash may force you to sell stocks, bonds or other securities at inopportune times, like after a sharp, short-term decline. Moreover, it may make sense to hold cash if you have large, known upcoming expenses or other short-term plans (e.g. money earmarked for a down payment on a property, a home remodel, tax payment, etc.). Subjecting all your liquid assets to short-term market volatility could jeopardise your ability to meet such near-term needs. But holding huge cash cushions isn’t always wise, and more and more cash doesn’t equal added safety, in our view, as doing so can expose diversified portfolios to other risks.
In Fisher Investments UK’s experience, one reason investors hold big cash buffers is to weather equity market volatility. Some investors we have talked to are willing to forgo some long-term returns in exchange for less short-term turbulence. However, we think this view can amount to overlooking risks beyond volatility. Here is one: inflation, which has averaged 2.4% annually in the EU since 1997.[i] We think it is important to account for this steady erosion of cash’s buying power.
Historically, interest earned on your cash may have offset this, either in part or in full. Yet now, with European deposit account rates near zero – or even negative – that isn’t likely to be the case.[ii] We have found some banks and brokerage firms are passing on negative interest rates to select depositors – either in the form of an actual negative yield or through increased fees.
But even beyond inflation and negative interest rates, our review of history finds that cash tends to be low returning, which can water down an investor’s returns during bull markets (long periods of generally rising equity markets) and reduces the power of compound growth (earning a return on not only your principal, but on past returns). Consider a hypothetical €1,000,000 portfolio. Assuming a hypothetical 7% annualised stock market return over 15 years (below global stocks’ long-term 11.0% annualised return), a 100% stock portfolio would grow to nearly €2,760,000.[iii] In contrast, a 75% stock/25% cash hypothetical portfolio – with the same 7% market return but a 0.5% annual cash return (lofty by today’s standards) – would rise to just under €2,340,000 over the same 15-year period. Now, investment returns aren’t nearly steady year to year like this, but we think this scenario helps illustrate cash’s dampening effect on diversified portfolios’ long-term growth capability.
We have also found investors hold cash to deploy after equities fall. From a high level, the logic may seem appealing – after all, many investors have heard of the investing adage buy low, sell high. But reality is more complex, in our view, since markets don’t announce buying opportunities. Stocks can enjoy long stretches of rising prices, so holding cash whilst waiting for a dip may come with a big opportunity cost of missed returns – akin to our aforementioned hypothetical example. Moreover, in Fisher Investments UK’s experience, the best times to buy are often periods when things seem the most bleak, making many investors feel unwilling to buy in. Our research shows investor sentiment closely follows recent market movement, so when stocks appear cheap is often when investor sentiment has turned quite dour. In that environment, we have found many investors prefer to wait for signs of a rebound before deploying their excess cash holdings. Yet negative volatility can end as quickly as it starts, and by the time investors’ moods have perked up, the opportunity to buy low may be long gone.
Diversified portfolios have room for cash, but to figure out how much, we think it is best to start by determining your specific investment goals and objectives as well as your risk tolerance. Do you need long-term growth and/or have cash-flow needs? Do you have a large purchase around the corner? Fisher Investments UK thinks these questions should help guide your asset allocation – your portfolio’s mix of stocks, bonds, cash and other types of securities. As a general rule of thumb, we think holding enough cash to meet between 3–12 months’ cash-flow needs is usually sufficient. Holdings exceeding that should raise questions in your mind, in our view, unless they are earmarked for a specific and relatively near-term purpose.
Outside short-term expenses and emergency savings, holding too much cash in diversified portfolios can be costly, in Fisher Investments UK’s view. We understand the desire to buttress against uncomfortable volatility but, in our view, investors benefit more by reframing their thinking. Rather than as a negative to avoid at all costs, we suggest treating the market’s turbulence as the price to pay for equities’ comparatively high longer-term gains.[iv] Holding too much cash may just end up flipping this risk around: short-term comfort in exchange for weaker longer-term returns – a potential setback for diversified portfolios’ ability to meet investors’ needs.
Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world markets and international currency rates.
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Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
[i] Source: FactSet, as of 08/11/2021. Harmonised Index of Consumer Prices, yearly, 1997–2021 (full dataset available).
[ii] Source: Norge Bank, European Central Bank, Danmarks Nationalbank, Bank of England, Riksbank, as of 08/11/2021.
[iii] Source: FactSet, as of 18/05/2021. MSCI World Index annualised total return, January 1970–December 2020.
[iv] See note iii.