The Pitfalls of Relying on Cash Investments

Cash holdings have risen to the highest level in five years, with Asia’s rich holding about 25%  of their financial assets in cash in 2017[1]. This figure is up by 4% as compared with 2016. Cash investments, such as savings accounts, offer a level of stability and liquidity that cannot be offered by other asset classes. The safety that cash holdings provide also matches with Asia’s long-standing money saving culture.

However, there are certain pitfalls tied to allocating a big portion of your wealth to cash holdings.

The Downfalls of Cash Holdings

Losing Value to Inflation

Cash is often held in a savings account with the purpose of keeping it there long-term. In Asia especially, people set aside money throughout their lifetime to save for big events far into the future, such as college tuition or retirement.

However, the purchasing power of your cash savings diminishes over time as inflation weakens its future value. For example, the latest inflation rate in Hong Kong was 1.9% in April [2], while the HKD saving deposit rate has been almost negligible at 0.01% [3]. Deposit rates remain well below inflation rates and are not likely to increase significantly in the near future.

As a result, your savings are unable to keep up with inflation levels, resulting in a loss of future wealth.

Excess Cash Investments Curbing Potential Growth

The cash set aside by wealthy individuals often exceeds the amount needed to cover short-term needs tremendously. This results in a loss of wealth growth, as the cash tied up in savings accounts and other cash equivalents could have generated higher return from other investment opportunities.

A low return on cash is to be expected with cash investments, as generally speaking, ‘the safer the investment, the lower the return’ holds true. For long term investment purposes, there are other options such as pension funds and stock market-linked investments that provide a better outlook in terms of growing your wealth. 

Portfolio Diversification to Put Your Cash to Work

Cash investments can still seamlessly fit in a portfolio diversification strategy tailored to your personal investment style, outlook and needs. Holding a globally diversified portfolio with multiple asset classes is key and can significantly boost returns over time, even when employing a low-risk investment strategy.

Cash needed for monthly expenses, unforeseeable emergencies and upcoming events should be kept in cash equivalents by individuals for optimal security and liquidity. Businesses will require a higher amount of cash, to take advantage of opportunistic acquisitions and to protect from market losses.

However, the remaining cash set aside for investment purposes can grow using non-cash investments with a higher return rate, such as bonds and stocks. 

Diversifying your portfolio does not mean you have to sacrifice continuous asset growth. Income related investment products provide a great alternative to excess cash investments as they also lead you to receive a fixed income on an established schedule.

There is a wide range of fixed income products to choose from, such as high-quality debts and dividend growing equities.

For individuals who prefer to maintain their cash investments, high yield checking and money market accounts typically offer better rates than savings accounts, although with higher minimum balance requirements. While offering more attractive real return rates, these cash investment options may also limit the number of transactions per month.

Prior to investing your cash, it is important to understand all terms and conditions applying to an asset class, especially if your goal is to maintain a higher degree of liquidity. 

Bottom Line

While a sufficient amount of cash should always be kept at hand for situations that require a high degree of liquidity, high net worth individuals often hold excess cash investments with low return rates that could be better invested in investment products with a higher return rate.

However, cash remains an essential component of a well-diversified investment portfolio. As such, take your personal objectives and risk tolerance into account to determine your ideal portfolio allocation structure and cash holding ratio.

BNP Paribas Wealth Management can help to tailor your investment strategy which aims at achieving an ideal balance of cash holdings versus other assets, based on your goals, investment objectives and risk profile.

Learn more about our bespoke portfolio management solutions here, or read more insights on the investment markets below.