Interest rates have been low for some time now – great for borrowers but bad news for investors. Looking ahead, there are signs that interest rates will rise, albeit slowly. We have had low inflation, so leaving your money invested in the bank at a low rate hasn’t led to a loss of purchasing power. Holding cash isn’t going to make you a fortune, but cash is still an important component of any investment portfolio. Your alternative choices are to invest in fixed interest, property or shares.
We are at a point in market cycles where holding more than usual in cash makes sense. In a rising interest rate environment, the market value of bonds falls, especially for bonds with a long maturity. Whereas conventional wisdom says bonds are conservative investments, at present they carry a high risk of loss of value. Alongside this, the share market is near its peak and at some point there will be a correction – that is, a drop in value. Holding more than usual in cash will offer two advantages in the medium term. Cash will offer protection against loss of value but also the opportunity to take advantage of any over-correction in the bond or share markets.
The best time to buy any investment asset is when the price is low. Market falls are driven primarily by fear and panic and at certain points prices can drop below what represents good value in objective terms. This means bargains are to be had.
It is also important to have cash on hand to cover your spending requirements when markets are volatile. This means you won’t be forced to sell investments at a time when prices have fallen. Having cash on hand gives you the luxury of time to wait until prices have risen again.