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Cash Investment Essentials: Insights and Takeaways

Posted by Alexander Hartmann on June 27, 2024

In this educational article, we will present some key takeaways from a research paper by Vanguard, titled “A Framework for Allocating to Cash: Risk, Horizon, and Funding Level” (April 2024). You can access the full paper at this link.

What is cash? Cash can take many forms, including physical currency, money held in bank accounts, and short-term financial instruments.

There is a clear need for cash in financial planning, but from a portfolio construction perspective, the need for cash depends on the investor’s circumstances and mindset.

Half of the households experience at least one financial shock over any 12-month period.

Around 8% of assets within defined contribution plans were allocated to investments resembling cash securities.

Although holding cash can provide a sense of security, that can come at the cost of underperformance and failure to achieve long-term financial goals.

Cash investment options should like any other investment be carefully evaluated as per pros and cons

Equities and bonds both have higher expected median returns than cash (exceeding them by 6.4% and 1.2% respectively).

In any given year, the probability of cash declining 10% is essentially zero, compared to an 11% chance for equities.

A 1,000 USD investment that earns 2% per year during a period of 3% annualized inflation will be worth more than 1,200 USD in 10 years. But in terms of purchasing power, that 1,200 USD will be equal to just over 900 USD of the originally invested money.

From 1960 through 2022, cash produced an annualized real return of just 0.7%, compared with 6.3% for stocks and 2.0% for bonds. Put another way, cash has barely kept up with inflation, a fact that would seem to create a significant hurdle to including cash as part of a strategic asset allocation.

Unlike long-term capital gains, interest – which is where most of the total return of cash comes from – is generally taxed as ordinary income, which means that it’s typically taxed at an investor’s highest tax rate.

Even after considering factors such as goals, risk tolerance, investment horizon, and funding level to optimize asset allocation, some investors prefer to hold cash as a part of their portfolio strategy. Cash may return less over time, but cautious investors may find value in the increased stability of their portfolio.

For a more detailed and bespoke discussion about your personal investments, contact us today. Our team at Society and PP Investment Education will assist you in many ways from reviewing an existing investment portfolio to the creation of an investment plan. The sooner you optimize your asset portfolio, the sooner you will be able to realize your dreams and secure a brighter financial future. You can contact Mr. Vladimir Popovski and Mr. Damian Panovski from PP Investment Education by sending an email to info@society-network.com.

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