Sun | Dec 4, 2016

Advertorial: Is cash really king?

Published:Friday | March 20, 2015 | 1:02 PM

"Cash is King" has long been propagated as the golden rule of doing business and investing, but is that really true? Is having cash the superior strategy in investing and business?

Cash, in its purest form, represents the most liquid asset in any portfolio and allows for individuals and/or businesses, to meet short-term needs or to capitalize on investment and/or business opportunities as they arise.

One therefore has to consider, the net effect of current returns and inflation on the cash.

The price of having cash and the flexibility that it comes with, is often a low rate of return.  In order to keep the story balanced, admittedly there are periods in which the return of cash is not negative in real terms.

For instance, in 2014, Jamaica’s Treasury bill rates averaged above 7 per cent, while inflation was approximately 6.4 per cent; additionally, there have also been periods in which short-term interest rates have spiked, resulting in periods in which real returns on cash was positive.

Conversely, the true cost of cash must also include the opportunity forgone, while sitting on the cash.

In the case of American investors who sat on cash, they overlooked the 11.74 per cent passive return in the U.S. stock market*.

Locally, a similar investor would have missed out on the massive rally in Government of Jamaica Global Bonds, or returns of 8 per cent - 9 per cent from a pool of low-risk funds while saving in cash for a long-term goal which would offer rates between 1 per cent and 4 per cent.

This begs the question, "Is your cash really still working for you?"

CASH DETHRONED:  ALTERNATIVE INVESTMENT OPTIONS

What’s next for the individual with this challenge is to now look at the other opportunities which may exist in equities, bonds, and alternative assets. 

This requires investors to re-evaluate their risk appetite, objectives, and time horizon and make practical investments accordingly.

While some local equities are currently underperforming, historically this asset class has outperformed its counterparts in the long-run.  In addition, investors may take the opportunity to purchase currently undervalued stocks, and hold in their portfolios for price appreciation then dispose of same and realize capital gains as a result.

Bonds also offer a good risk and return trade-off, as it provides an opportunity to capitalize on good yields in that market. 

This asset class accommodates clients with risk profiles from conservative to aggressive, and provides steady inflows from coupon payments.  

The conservative investor may choose to invest in investment grade corporates or sovereign bonds, at yields above interest rates currently earned on cash. 

For the moderate investor, they may choose to do a mixture of investment grade, for stability, and non-investment grade bonds to increase the overall portfolio yields. 

Aggressive investors can weight their portfolio more heavily in non-investment grade bonds, with the possibility of high yields and the corresponding risk. 

Executed properly, this creates the opportunity for a huge payoff of coupon payments and capital gains.

Alternative assets, which include but are not limited to corporate issues, mutual funds, indexed instruments and real estate, also offer the opportunity for great returns. 

A real estate investor for instance, can enjoy steady cash flow from leasing properties in United States dollars, and additional returns upon disposal of the property.

Cash is critical to any portfolio strategy and for the efficient operation of a business, however, given its low return nominal and real, it is even more critical to find the optimal level of balance.

So cash is not King, at best it is more like a Knight, given that its role is not to rule over the portfolio, but to act as a key agent in defending the objectives of the portfolio. 

(*Measured by the return on the S&P 500 where dividends are not reinvested.)

- Advertorial