The Role of Cash in Your Investment Portfolio

Many multi-asset fund managers are holding more cash than usual at the moment - but should individual investors do the same?

Emma Wall 8 November, 2017 | 12:04AM
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Emma Wall: Hello and welcome to the Morningstar Series "Ask the Expert". I'm Emma Wall and joining me today is Dan Kemp from Morningstar Investment Management.

Hi Dan.

Dan Kemp: Hello Emma.

Wall: So, we’re here today to talk about cash, because it seems that many multi-asset managers are holding more cash than usual and indeed in Morningstar Investment Management's own portfolios you are holding more cash than usual, why is that?

Kemp: That’s absolutely right. I think that reflects the opportunity set. So like other multi-asset managers we're not constrained to some sort of benchmark. We're looking for opportunities to invest people's capital to deliver a return that’s better than the risk they are taking. And at the moment with prices so elevated there are very few opportunities that we see where that’s the case. And so, in that situation it's good to have some cash to keep your powder dry and look for better opportunities.

Now remember in the past it's been the case where you could have held equities or when they look unattractive, bonds have looked attractive. So, you could offer it a sort of seesaw effect. That’s not really the case at the moment and that’s why we are holding bit more cash.

Wall: And what is the role of cash in a portfolio, is it just simply that you are ready to go when those opportunities arise.

Kemp: Well that’s certainly one of the reasons for holding cash. This idea of keeping your powder dry. But we have to remember that although cash is quite a safe investment in the short term. It's very, very dangerous in the long term. So, at the moment as we all know despite the interest rate rise we still have very low interest rates, interest rates that are far below inflation.

So, if you were just to hold cash in a let's say a current account then over the next 20 years, you'd probably lose out about 60% of the gain versus inflation, and that’s a huge loss. It's very, very dangerous over the long term, and so people shouldn’t be complacent about holding it. But it’s a great way of holding your money once you've used all the opportunities that you see that were available, then to hold back and wait for new opportunities to appear.

Wall: Now we all know that interest rates are incredibly low despite the recent bump and inflation is looking higher than it has been in recent history. So why are we still so attached to cash.

Kemp: Well, the old adage cash is king really reflects our behavioral biases. There are two particular biases I think that are at play. The first is loss aversion, that we hate losing money much more than we enjoy making it. And of course, with cash unless your bank goes bust unfortunately that’s not an issue for most people, then that will protect your money we value that protection probably more than we should.

And then secondly this present bias or temporal myopia that we tend to focus on the short term rather than the long term. So, we much rather as humans surety in the short term than the possibility of much more gain in the long term.

And that's a bias that we need to overcome, as investors we constantly need rethinking about the long term rather than just the short term. And arguably if you're someone is going to suffer from these biases or you've struggled to control these biases, might be better just to invest and forget about it for 20 years. We know most people can't do that and most people can't stomach that sort of volatility. So, cash has a role, but focus on the long term and remember that we have these biases that lead us in the wrong directions.

Wall: Dan, thank you very much.

Kemp: Thank you.

Wall: This is Emma Wall from Morningstar. Thank you for watching. 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar

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