Cash is king but not without risk

Risk can be found even in places of apparent security.

Cash is the undisputed king of the investment world at the moment. That is hardly surprising given the Eurozone debt imbroglio – and a US political landscape that is hardly conducive to tough political decisions on reducing federal debt as we head into a presidential election year.

A random survey of the financial planning community at the moment tells a consistent story – investors are pessimistic and opting for short-term security over long-term growth.

Where is the risk in that? Well that depends on your age and circumstances.

Major banks at the moment are offering 5 year term deposits around the 5.5-6% mark. Given the past 5 years on the Australian sharemarket have returned about 2% as measured by the S&P/ASX 300 index, that does not seem like a bad deal – and effectively capital guaranteed as well.

But if you are not going to retire for another 20 or 30 years does it still make sense? Or if you are newly retired and are more concerned about capital protection is the argument even stronger?

Sharemarket data research group Andex recently prepared a risk/return analysis over 20-year periods dating back to the 1950s.

The median 20-year return produced by Australian shares from 1950 to 2010 was 12.9% using rolling month-end figures.

The worst 20-year period was the 20-years to the end of February 2009 when the Australian market returned 8.4%.

Now there is nothing to indicate that returns over the next 20 years may not be worse, but what that analysis of our sharemarket returns shows is that an investor opting for term deposits for their entire portfolio is taking a very pessimistic view about the Australian sharemarket indeed – and by extension, the entire Australian economy and the major companies that dominate our sharemarket.

In simple terms, the bet people moving completely into cash are taking, is that over the long-term the Australian sharemarket will produce a return well below the worst 20-year return seen over the past 6 decades.

Past performance is no indication of future returns but it does provide a historical context and framework, particularly where emotional influences are possibly pushing us towards the extreme end of an asset allocation decision.

This is not to say that a conservative asset allocation is incorrect, rather that things other than short-term market sentiment should determine your asset allocation. A recent retiree can argue powerfully that capital protection is the overriding driver of their portfolio today given the risk in the developed world economies. But the average retiree has a life expectancy of 20 years, so they do still have the luxury of taking a long-term view.

The key point here is that it is not about taking extreme bets – either 100% in cash or 100% in the sharemarket – but rather the need to balance the portfolio’s asset allocation based on factors like age and ability to withstand market shocks.

A long-term perspective is a great ally in periods of extended market volatility, but it is even more effective when coupled with a balanced, diversified approach.

The following article has been sourced from Vanguard Investments Australia Ltd.

Important Information

The above information provides an overview or summary only and it shouldn’t be considered a comprehensive statement on any matter or relied upon as such. The above information doesn’t take into account your personal objectives, financial situation or needs. It’s important for you to consider these matters before making any financial decision and I recommend you seek help from a financial adviser.