Cash, rarely a good idea?
Here at MIplc, we thought it would also be useful to explain how Morningstar use cash within our risk rated portfolios.
So, to start, let us think about why people tend to love cash. Markets go up and down, creating a rollercoaster of emotions over your financial journey. During the harder times, people find comfort in cash – a natural reaction (even if it is likely to be detrimental because investors often panic-sell assets, to raise cash, after a period of losses). But cash is even more important when markets are considered expensive, like they are now, meaning that the risk of loss is elevated. To steal from Warren Buffett, we want to “be greedy when others are fearful and fearful when others are greedy”, increasing our cash holdings, when other investors are piling into overvalued assets, in the hope that they will go up forever.
We should also keep in mind that the return on cash (interest) typically fails to keep pace with the rising prices of goods (inflation). Therefore, as a long-term pursuit, cash is likely to be a very bad investment. Hence, unless we have absolute certainty that the markets are nearing the peak, which we almost never do, putting everything in cash is rarely a good idea.
Morningstar use cash, selectively, as an investment tool. This is routine within our risk rated portfolios, where cash is treated like any other asset class available for allocation. This means that as the attractiveness of other available assets rises relative to cash, cash allocations should fall and vice versa. Therefore, cash plays both attack and defence, by being used as ‘dry powder’ for adding undervalued assets to the portfolios and by buffering against rich valuations.
This brings us to a crucial aspect of wealth creation and preservation – we need to be a step ahead of our own emotions. Ultimately, we are dealing with our own ‘animal spirits’ when we invest – a concept famously referred to by the legendary economist John Maynard Keynes. So yes, cash may feel like the best place in the darkest moments (so-called “cash is king”), but it is a poor choice when considered as a long-term pursuit and only tends to work if we increase it before the market decline occurs.
This is where we need to be balanced. A big part of wealth creation is avoiding the biggest mistakes and panicking into cash is one of the most well-known actions to avoid. Bringing this together, we want to reiterate that your cash level should be thoughtfully considered and is a key tool in helping you reach your goals.
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Melville Independent PLC's risk rated portfolios are managed by Morningstar.
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Risk-rated portfolios are not suitable for everyone, and you should seek advice from a suitably qualified adviser before making any decision to invest.
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