Insight

Episode 1 - Don’t miss opportunities by holding too much cash beyond short term needs

21 August 2024
Invesco

Saving in cash has advantages and disadvantages

  • There are many ways that we can accumulate our money and grow our wealth. One of the simplest ways is to hold cash.
  • Especially in times of uncertainty, it’s easy to fall back on the old saying “cash is king”

Advantages of holding too much cash

  • People choose to accumulate money by holding cash primarily because it is convenient and liquid, and oftentimes savers want to “set and forget” without looking at the investment market.
  • Experts agree that everyone should generally have cash savings available for emergencies, generally equal to around three to six months living expenses. 

Disadvantages of holding too much cash

  • Problems arise when investors sit on too much cash, exposing portfolios to hidden risks. 
  • The key risk - lower returns: Money sitting in a current account does not generate any income or grow in value.
  • Inflation, meanwhile, erodes the purchasing power of your current cash, meaning you won’t be able to buy as much with it in the future.
  • This is why investors seeking long-term wealth creation make investments in different asset classes within their portfolio. 
  • Although these assets are riskier than cash, and thus carry a risk premium, evidence shows that over the long-run, these assets and markets generally maintain a steady, upwards trend. 

How to visualize inflation? Take a look at a hamburger lunch set 

Suppose you can buy a burger set for $40 today and the annual inflation rate is 4%. Next year, the same burger set will cost 4% more at $41.6. It does not seem much, right?  But over time, inflation will increase the cost of the burger dramatically. 

Source: Invesco, as of July 31, 2024. For illustrative purpose only. 

Two main asset classes to consider – Equity and Bonds

Equity

  • An investor purchasing a company’s shares effectively owns part of the company.
  • A shareholder may be able to get dividends.

Why do share prices go up and down?

  • Equities trade on stock exchanges and are bought and sold by investors throughout the trading day.
  • If there are generally more buyers (i.e. demand) in a stock than sellers (i.e. supply) at a particular time, the stock price will go up – if sellers outnumber buyers, the stock price will drop.
  • Factors that affect stock price include corporate earnings and overall market sentiment.
  • In general, growth in corporate earnings at a company is positive to its share price.
  • On the other hand, if the market holds a positive view on the macro economy, this also supports the price of equity markets.

For illustrative purpose only. 

Corporate earnings

Corporate earnings are after-tax net income of a company. Earnings can be invested in the business to increase its earnings in the future, or they can be used to reward shareholders with dividends.

Market sentiment

Market sentiment is the current attitude of investors. Emotion often drives the stock market, so market sentiment is not related to the fundamental value of a stock. Market sentiment reflects investors’ concerns, expectations, and emotions about the market and broad economy, while fundamental value is about real business performance.

Advantages and disadvantages of investing in equities

  • By investing in equities, investors are hoping to get capital gains (that is, price appreciation) as well as potential dividends.
  • At the same time, equity investors are subject to loss if the market turns volatile or company fundamentals deteriorate. 
Global Equity total returns in the past 30 years, Total return = 922.9%; average annualized return = 8.05%

Global Equity is represented by MSCI AC World Index. Indexed performance (base 100).

Source: Bloomberg data, as of July 31, 2024. For illustrative purpose only. Investment cannot be made directly in an index, Past performance is not a guide to future returns.

Bonds

  • When a company or government issues a bond, it has agreed to repay capital plus interest on set dates.
  • A bond investor, in effect, has lent money to the issuer.
  • In return, the bond investor usually receives a fixed payment from the bond issuer.

Why do bond prices go up and down?

Factor How does it impact bond prices?
Interest rates Interest rates and bond prices move inversely – this means that when interest rates go up, in general, current bond prices go down and vice-versa. 
Market conditions When the investment market is risk-off, investors typically move to bonds from equities. Current bond price could go up in this environment.  
Credit Ratings Bonds are assigned credit ratings by ratings agencies, such as Moody’s and Standard & Poor’s.  The rating reflects the agency’s view of the issuer’s ability to pay interest and principal.  If a bond’s credit rating is downgraded, the bond price will likely fall and its interest rate will go up (since bond investors will demand more interest for taking on the additional risk of default).  

Risk off

Investors typically want to sell assets they see as risky when they are pessimistic about the outlook for the economy, or unexpected news comes out that increases uncertainty. This is described as a “risk off“ environment.

Credit rating

Credit rating agencies use letter designations such as A, B, C to illustrate the creditworthiness of a bond issuer. Higher grades represent a lower probability of default. Higher rated companies are considered investment grade. Issues that are investment grade are rated as "BBB-" or "Baa3" or higher by ratings agencies such as Standard & Poor's and Moody’s. High-yield bonds are corporate debts that have lower credit ratings than investment-grade bonds. They pay higher interest rates but are more likely to default.

Advantages and disadvantages of investing in bonds

  • By investing in bonds, investors are aiming to get regular income. Income generated by bonds is typically higher than current savings rates. Bond investors will get back the principal when the bond matures, except in the unlikely event of a default.
  • The disadvantages of bonds are that they are subject to interest rate fluctuations, market volatility and change in the issuer's financial position.  

Default

A default happens when a borrower fails to make required payments on a debt, whether of interest or principal.
Global Bond total return in the past 30 years, Total return = 209.3%; average annualized return = 3.83%

Global Bond is represented by Bloomberg Global Aggregate Total Return Index. Indexed performance (base 100).

Source: Bloomberg data, as of July 31, 2024. For illustrative purpose only. Investment cannot be made directly in an index, Past performance is not a guide to future returns

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