What should you do with cash

Stock markets are now at all time highs. Who would have thought that we would be saying that after the Global Financial Crisis back in 2008. Surely equity markets are now toppy? Many investors who went to cash around then have been too frightened to come back into the market in the intervening period and are now only considering re-entering after an almost 200% gain in stock prices. If anything this sounds like a classic scenario of “sell low and buy high”.

It is really important to know that cash is treated by serious investors not as a safe haven but as a source of liquidity. Cash returns over time, and especially in the current environment, are always the lowest on average when compared with Bonds, Property and Equities. This is not to say that there are guaranteed returns with the basic asset classes or that cash won’t outperform other assets in the short term. Statistical analysis over time, does however, indicate that other asset classes outperform cash.

The reason for this is that such other asset classes carry risk, some more than others. This, in turn, enhances the possibility of higher returns. And even then, certain elements of each individual asset classes may carry higher risk when compared to similar investments. For example buying shares in a company that has a high level of debt carries different risks than those which have no debt. Likewise, long dated government bonds are most likely to suffer big price falls when interest rates rise especially when compared to the prices of short dated bonds with only a year or two to maturity.

So the question that needs to be asked is “What is your time frame?”. If it’s only likely to be the next year or two before you need to spend the money then my advice is stay in cash. Not because I think markets will fall again but because if someone needs liquidity for future purchases, then cash needs to be set aside. For time periods of 2 to 6 years you need to take into account life transitioning issues. If your perspective is 6 to 10 years then, based on historical evidence, it is likely that cash will be the poor relation over that time period. This isn’t to say that markets won’t be volatile. They undoubtedly will. But if you always have cash to hand for what you need to do with your life, then short term stockmarket volatility won’t matter.