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Is Cash Really King?

by Mark Causer

There have been many articles written on the Global Financial Crisis (or GFC as it is now commonly referred to); so much so that I am sure the acronym is headed for the Oxford Dictionary! It is hard to find ANY story that provides an optimistic short, medium or even longer term view (insert country of choice to suit your argument).

All of this volatility has made global investors extremely nervous. As a result, many have flooded back to the supposed safety of ‘cash’ (term deposits, savings accounts, cash management trusts) - billions of dollars have been transferred back into cash. Investing money into cash has never made anybody wealthy, however Australians are now more aware that the Government will protect their cash (up to $250,000) and over the last few years cash has managed to contribute a positive return to their investment portfolios. Therefore the obvious thing to do is move to cash to avoid risk!

But how safe is this strategy? Is cash really King or possibly the Court Jester?

Let’s examine this and what we know to be 100% correct. The first chart looks at the performance of $1,000 invested into Australian shares in December 1979 and track the performance through to 2011 – an increase in wealth to approximately $31,000. Remember, this is factual (historical) information.

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For those with a keen eye, you will see the dip associated with the stock market crash of 1987. If you take an even closer look, you might be able to make out the price movements relating to several other major global financial events, such as;

  • Black Monday (19 Oct 1987)

  • Russian crisis (17 August 1988)

  • Friday the 13th mini crash (13 Oct 1989)

  • Japanese asset bubble 1991 (13 years - 2003)

  • Black Wednesday 16 Sept 1992

  • Asian financial crisis July 1997 and follow-on Oct 27 1997

  • Dot Com bubble (March 2000)

  • Stock market crash (Sept 11 2001)

  • Stock market downturn ( 9 Oct 2002)

  • Chinese stock bubble (Feb 2007)

  • US bear market (Oct 2007 - June 2009)

  • Financial crisis Sept 2008

  • Euro debt crisis April 2010

  • Flash crash (6 May 2010)

  • August 2011 stock crash

The point is that these major events are barely visible when the share market performance is projected over a longer timeframe. We can even ‘smooth’ out the graph – the result is still the same.

So, over the longer term (1979 – 2011) the Australian Share market has performed very well. But how does it stack up against term deposits? The chart below compares the rate of return on an investment of $100,000 in term deposits and Australian Shares.

Financial KeysAs you can see, in the very early years, the rate of interest on the term deposit outperforms the dividend income on shares – but only for a short period of time, maybe five years at best. This is very similar to the performance of term deposits and our share market over the last five years as well!

However, after the first say five years, the income return on shares outperformed term deposits substantially and continued to do so thereafter – through all the major global financial events mentioned earlier. The second chart compares the total return on your $100,000 investment into both term deposits and shares

The result here is self-explanatory.

Stock markets around the world may well struggle to deliver the same performance over the next 30 years or so, but the strategy of investing into well managed companies that continue to pay robust dividends has historically shown to be a worthwhile investment. It is highly unlikely that as many countries around the world and their constituents de-lever themselves, that interest rates will rise in a material fashion i.e. they will most likely remain low for some time. There will also be those that will say the ‘buy and hold’ strategy is no longer relevant. They may be proven correct, however there will be no bells ringing to tell you when to buy and when to sell and many investors could well suffer investment fatigue in constantly changing and re-arranging their investment portfolios.

Therefore, the more prudent course of action may well be to simply buy a quality investment and hang onto it – don’t expect it to double in value overnight!

If you consider a retired couple today, aged 65 years, they will live (on average) for another 20 years. If you consider the results from the various charts above, the riskiest asset class that they could invest into for the longevity of their finances, would appear to be cash and term deposits and not the commonly held belief that equities are the risker investment!

 

August 1, 2012
 
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