Sometimes, keeping a little cash in reserve is a good thing
When the comment is made about someone that ‘they keep their money under the mattress’ it usually implies that the person is suspicious of all financial institutions and has little or no investment knowledge – and it’s not meant as a compliment! But is there ever a time where keeping your money under your mattress – or at least out of more volatile investments and sitting in the relative safety of the bank – is a good thing? Let’s consider the current circumstances.
Interest rates are at record lows, which means that other than a few exceptions, investment returns across the board will be relatively low. The stock market will normally perform better than the cash rate, but let’s assume a return of four per cent on your investment annually (that’s four per cent of the share value in dividends, not a four per cent increase in the share price).
As an example, let’s assume you invest $50,000, which will give you a $2,000 dividend return for the year with that four per cent return. This would be above what you could achieve by depositing your money in a bank (the best rates currently range from two to three and three quarter per cent, but these rates require regular deposits and no withdrawals, otherwise the interest drops to fairly negligible levels). So shares would be better.
But what about the share price?
The primary reason for the RBA lowering the interest rate is to stimulate the economy. Among other things, this stimulation is designed to increase consumer spending, leading to increased profitability for businesses, which should help lead to increased share prices. The fact that rates are at all-time lows should give you an indication of the ongoing state of the economy – some well-respected commentators are even throwing the term ‘recession’ around.
The ASX All Ordinaries index is reasonably close to the 25 year trend line (the line approximating the average growth in our stock market over that period), so it is unlikely to drop in a similar way to 2008, where it halved from the high six thousands to little more than three thousand over the course of eighteen months. But what if it falls by ten per cent over the next year? What about twenty per cent? In those situations, your $50,000 would turn into $45,000 or $40,000 respectively. And that’s the market average, what if the companies you have shares in drop by more than that? Or collapse altogether?
So, if you don’t see any stocks that are recession-proof, keeping your money in the bank may not be the worst thing in the world in the short-term. Barring a catastrophic collapse of the economy, your money is safe. Yes, you will miss out on potentially better returns, but you might also miss out on significant losses as well.
There’s also another benefit in keeping your money out of stocks in a shaky market. Let’s say you bought 10,000 $5 shares with your $50,000. If you don’t buy and those shares drop by twenty per cent, you could then purchase 12,500 shares for the $50,000 (an improvement for your portfolio of twenty-five per cent).
Now, all of the above is hypothetical. The market could just as easily continue with steady growth in response to the low rates and your investment could grow in value as well as provide dividends. The key is to be open to all investment options and to create a balanced portfolio, which in times like these could easily benefit from having a little cash in reserve.
By Troy MacMillan