Cash: King for the timid, trash for the wealthy?

In the real world, we never buy something with a share certificate, a brick or a gold bar. So how is it possible that cash is often viewed as trash?



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One of the problems with historically low interest rates is it reinforces the idea that cash is “trash,” a worthless asset destined to lose ground to inflation. That’s a pity, considering that cash is a major asset class, behind only stocks, bonds and perhaps real estate.

Cash is special, if only because it’s always useful for purchasing any of these other asset classes. That’s why deep-value investors always like to set aside a chunk of their portfolios in cash so they can snap up bargain-priced stocks during panic sell-offs. This is what they call “keeping your powder dry.”

In a sense, cash is like an investor’s oxygen. It’s everywhere and we must breathe it to survive. How do we assess the value of a business or stock? Largely by how much cash (or dividends) it throws off. Real estate? By the amount of rental income it generates, which is just another form of cash. Longer-term bonds? By the coupon or interest paid out, which in the end is yet another variant of cash.

It’s an obvious point but in the real world, we never buy something with a share certificate, a brick or a gold bar. We put up cold hard cash or its electronic equivalent via a debit card or credit card.

The disconnect between cash today and investing for tomorrow

So how is it possible that cash can simultaneously be viewed as “trash?” The disconnect arises because of the concept of investing for a far-off future. In order to maximize cash in old age or at least five years from now, investors try to transmute cash into various alternatives that promise but rarely guarantee better returns than cash can generate in the short term. At the same time, though, they are embracing risk of loss, a fear that has been more or less pervasive ever since the stock market crashed in 2008, taking with it just about every other asset class except: well, you know, cash!

As veteran Dow Theory theorist Richard Russell often points out, in a bear market when most other asset classes are falling, those holding only cash are participating in a bull market in cash. Even if interest rates were zero, relative to plunging wealth elsewhere, breaking even with cash would be a good thing. Lately, Russell has been bearish with a preference for cash and gold.

Many small investors appear similarly skittish. For the many burned by the financial crisis and its aftermath it seems to be a valid case of “once bitten, twice shy.” A survey issued mid-July by BlackRock Canada’s iShares of 551 Canadians with at least $100,000 in financial assets found  market fears are indeed driving investors to cash even though most still expect poor returns. See David Pett’s report in the FP here.

A “guaranteed negative return?”

Seventy-seven per cent believe the fear of poor market performance is driving investors to boost their cash holdings, even though 67% view cash as ultimately leading to “a guaranteed negative return.”

iShares head Mary Anne Wiley (who is also managing director of BlackRock Canada) is adamant that “holding cash is not the answer.” Naturally, she believes ETFs that hold high-yield corporate bonds, emerging market sovereign debt or dividend-paying stocks are all better choices for long-term investors. Most ETFs are almost as liquid as cash since they can be sold on stock exchanges throughout the day (although with no guarantee of selling at a profit).

The wealthier the investor, the more likely they are to eschew cash for such alternatives. The survey finds HNW (High Net Worth) investors with at least $250,000 of investible assets are more likely to seek liquidity (57% of them do so) and 46% are more likely to seek diversification by sector, including (in 37% of cases) access to foreign markets. Foreign exposure is viewed as particularly important for those with at least $500,000 to invest.

The survey also underlines a noticeable lack of confidence in any investment decision made in the current economic environment. Sixty-eight per cent of the wealthy investors surveyed feel “much less confident” about their investment decisions than they were in the past and they’re also a lot more conscious about investment costs.

The survey doesn’t get into it but investors don’t have to choose between all-cash and all-equities. This shouldn’t be an “all or nothing” decision that keeps you awake nights if you make the wrong choice. There are various hedging strategies available, many of them using inverse ETFs or ETNs (exchange-traded notes), which let you participate in the hope of stock gains while also hedging some of your portfolio against downside risk. But a full treatment of this topic is for another day.

4 comments on “Cash: King for the timid, trash for the wealthy?

  1. Using Inverse ETFs to adjust a portfolio's stock market exposure is a great strategy that works.
    Build a strong foundation of individual bonds, GICs, preferred shares, then add a core of dividend paying stocks. As market conditions dictate, add inverse ETFs to reduce your exposure to the overall market or just certain stock market sectors. And, best of all, you are not disturbing your investment income stream nor triggering taxable gains/losses.
    As conditions improve, reduce and eliminate your inverse ETFs and add Index ETFs to enhance the portfolio's stock market exposure. Again, your investment income stream remains intact and no income tax events are triggered within your 'core' holdings.
    This is where cash is a great asset. It gives you the flexibility to adopt certain investment strategies.

    P.S. – This strategy will not work if you try and use 'leveraged' inverse ETFs which are better suited to day trading strategies due to their structure and daily settlement.


    • George, great strategy. I used something similar … I use TFSA account as my "play" money, no tax implication. I bought some oil & gas stocks that pay high dividends, such as COS & HSE, while I also bought HOD (Horizon Betapro 2 X leveraged inverse ETF on oil price . … I know I was being "bad" for using leveraged ETF). When oil price droped a while, I got out of HOD. Meanwhile, COS & HSE are still earning high dividend and I don't have to sweat about stock price drop in HSE & COS when oil price drops. Some days I do get caguht with all HSE, COS and HOD drop, though.


      • Hi, Sandy.
        Well done.
        I only suggested not using leveraged inverse ETFs because most of us are not great at trading, consistently. (Or maybe it just me.) And the longer you hold leveraged ETFs the greater the distortion in their tracking error.
        If a person is able to successfully trade, one nice characteristic of Inverse ETFs is they require a smaller cash commitment, as you already know.
        Have a great day!


  2. Well if you dig a little deeper,you will find that Mary Ann does not manage her own money. But she talks a good game,most pro active investors are 40% cash,40% bonds ,reits and pref. with only 20% div. shares . That 40% cash will move into etf's as the market trust comes back….no sign of that happening anytime soon.


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