Is cash king, long term?
AUSTRALIANS have flocked to term deposits and high interest savings accounts over the last few years. But the current low rate environment makes it worth wondering if cash is king when it comes building wealth, long term.
As 'income' assets, savings accounts and fixed term deposits offer some very useful pluses. They are generally low risk and the known return lets you budget more easily.
However, cash investments have downsides. The returns are fully taxable, and because these assets involve very little risk, the rate your money will earn is also low. This issue has become even more pronounced following cuts to official interest rates in late 2011.
Right now, the most you can expect to earn on a 12 month deposit is around 5.4% with UBank or ING DIRECT. Even if you lock your money away for five years, the best return is about 5.5% through Greater Building Society.
I'm a firm believer that at least part of your portfolio should be invested in cash. However exposure to growth assets is essential. Income investments offer no capital growth, and that's a serious issue when you are talking about long term investing.
Growth assets, which include property, shares, and units in managed funds that invest in these assets, offer ongoing income in the form of rent, dividends and distributions, which come with valuable tax breaks. More importantly, growth investments offer long term capital growth - something that will help your money keep up with, or outpace, inflation.
If you think about it, inflation is currently 3.1%, which means $10,000 sitting in the bank today will only have purchasing power equal to $9,690 in a year's time. Assuming inflation remains unchanged, after two years, that same sum will only buy $9,389 worth of goods and services. This is why capital growth is so important. It protects your wealth from being carved up by rising prices.
I realise that plenty of investors have been rattled by sharemarket falls in recent years, and there is no doubt it can be extremely stressful when the value of an investment drops. However history shows that markets recover, and it can be just as damaging to your portfolio to be seduced by secure (and fully taxable) returns on bank deposits.
The lack of capital growth earned on cash deposits is the 'opportunity cost' you face as an investor. And it is something we often don't see until the passage of time reveals that our money simply doesn't buy as much any more.
I'm not trying to second guess where the sharemarket or property market is heading, though the prices of both are low at present and atrguably there are good buying opportunities available. If you are looking for instant diversity across these markets, or you don't have much cash to invest, a managed fund offers an easy way to gain access to growth assets. In many cases you can start out with as little as $1,000, and plenty of managed funds offer regular savings plans that let you build your investment over time.
For more information on why it's so important to invest in a mix of income and growth assets, head to www.paulsmoney.com.au and download a copy of my e-Book "10 keys to successful investing". It offers sensible tips to build a healthy long term portfolio.
Paul Clitheroe is a founding director of financial planning firm ipac, chairman of the Australian Government Financial Literacy Board and chief commentator for Money magazine. Visit www.paulsmoney.com.au for more information.