Why Cash Won’t Cut It for the Long-Term - Articles & Commentaries

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18 September 2024

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Cash has long been considered a safe, reliable asset class, providing a sense of comfort and stability, especially in times of market volatility. It’s easy to see the appeal—cash is liquid, accessible, and doesn’t come with the same risks as equities or bonds.

However, with global central banks preparing to lower interest rates, the allure of cash may be fading. Relying on cash alone for long-term financial planning could be a costly mistake. Here’s why:

1. Battling Inflation

One of the most significant risks of holding cash over an extended period is inflation. Inflation slowly but surely erodes the purchasing power of your money. The RM100 in your savings account today will not have the same value in the future as the cost of goods and services rises. While your cash remains static, inflation continues to chip away at its real value.

Over the years, inflation can dramatically reduce the value of your savings. In contrast, a well-diversified portfolio composed of equities and bonds, have the potential to outpace inflation, preserving and growing your wealth. By relying solely on cash, you’re essentially locking in a loss over time.

2. Missing Out on Growth Opportunities

Cash, while safe, lacks the potential to generate significant growth. Over the long-term, other asset classes like stocks, bonds, or real estate offer far greater potential for compounding your wealth. Historical data consistently shows that equities, for example, deliver higher returns than cash, despite occasional market downturns.

By choosing not to invest and keeping your funds in cash, you forgo the opportunity to participate in this growth. While cash can provide short-term security, it lacks the ability to build wealth over time, particularly when compared to the power of compounded returns from investments.

3. Limited Income Generation

Another drawback of holding too much cash is its inability to generate income. Investments in stocks can provide dividends, bonds generate interest, and Real Estate Investment Trusts (REITs) offer rental income. These income streams are crucial for long-term financial growth, especially in an environment where expenses tend to rise over time.

By holding your assets in cash, you miss out on these passive income opportunities. Over the years, income from dividends or interest reinvested back into your portfolio will also compound and grow your wealth.

4. Opportunity Cost

Every decision to hold onto cash is a decision not to invest in higher-return opportunities. This concept, known as opportunity cost, highlights one of the most overlooked dangers of holding too much cash. While it might feel safe to keep your assets in cash, the reality is that you're potentially sacrificing much greater returns by not putting your money to work.

Stocks, bonds, and real estate offer varying degrees of risk and reward, but each has the potential to outperform cash significantly over the long-term. Even conservative investments, such as government bonds, generally provide better returns than keeping money in a savings account. By holding too much cash, you're leaving potential returns on the table, reducing the overall growth of your wealth.

5. Lack of Diversification

A well-diversified investment portfolio spreads risk across various asset classes—stocks, bonds, real estate, and cash. This balance allows you to manage risk effectively while maximising your returns over time. Relying too heavily on cash, however, creates an imbalance, concentrating all your assets in a single low-yielding area.

Diversification is a cornerstone of successful long-term investing. By keeping your assets too concentrated in cash, you’re exposing yourself to a different kind of risk—the risk of underperformance. Investments in different asset classes help to smooth out returns over time, ensuring that you're not overly reliant on any single asset type.

Cash Has Its Place, But It’s Not Enough

Cash has a purpose in any well-rounded financial plan. It provides liquidity and serves as a buffer during emergencies or when market conditions are unfavourable. However, over-relying on cash is a short-sighted strategy, especially when it comes to building long-term wealth.

The key is balance. Cash should be a part of your overall financial plan, but not the cornerstone of it. A well-diversified portfolio that includes stocks, bonds, and other investments will help you stay ahead of inflation, generate income, and take advantage of growth opportunities. This approach allows you to reduce risk while ensuring your assets are working for you over the long-term.

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