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Cash vs Equity – Which investment carries more risk?

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There is no doubt that the year 2020 will go down in history for a number of reasons. When considering the stock market, it will never be forgotten. This year we saw one of the fastest and most aggressive equity downturns in the last 100 years, rivalled only by the 1929 stock market crash.

In late December and early January, the investment community began hearing rumblings of a virus in China that had local authorities slightly concerned. Most of us didn’t give it a second thought. By the middle of February, the virus, now known as Covid-19, had spread across the world, causing panic amongst health professionals and financial markets alike.

At one stage, a Bloomberg reporter said, “if it is listed on an exchange, it is being sold.” Not even Bonds, Gilts, Treasuries or Gold could escape the sell-off. Countries began closing their borders, and governments shut down business activity. Financial markets plummeted 30% or more as the global economy came to a grinding halt. It has been a stark reminder of how quickly equity markets can move against you. Many investors will be questioning the need to be invested in riskier assets. Is the risk worth the reward?

When asked the question “Which investment carries more risk – cash or stocks?” what would you be inclined to say? Stocks, most likely. The answer, Warren Buffett argued in a letter to his shareholders, is cash, hands down, without a doubt.

Many retirement investors think cash is a safer investment than equity. But, it should be the other way around. Due to inflation, a relentless force that destroys purchasing power, cash is the absolute loser.

The problem, Warren Buffet argues, is that investors, textbooks, and business schools incorrectly equate volatility with risk. While this makes for easy teaching, volatility is far from synonymous with risk, he says. Fluctuations in stock prices are not risk; they are opportunities. Risk should rather be defined as permanent loss of capital, caused by inflation. You cannot reverse inflation. But an investment in the equity market, while it may rise and fall, can reverse downturns, and yield a positive, real return. Buying publicly traded shares is not risk- free but avoiding stocks for the “safety” of cash is a mirage and dangerous for your retirement portfolio.

To preserve the long-term purchasing power of your wealth, investors need to generate a return that is equal to or preferably higher than inflation. In any given period, equities could underperform cash, but if your return requirement is more than cash can deliver, holding cash will guarantee that it falls short of this objective. With historically low-interest rates, investors need higher-risk strategies to achieve that required return.

In South Africa, however, over the last five years, cash has yielded higher returns than S.A equities. But over the longer term, stocks have significantly outperformed cash. We will never know for certain how equities might perform, but what we do know is that investing in cash will always cap your potential upside to no more than 2% above inflation.

A widely used stock market phrase says, “It is time in the market, not timing the market” that counts. It is often argued that for long -term investors, the most effective entry point is when headlines are gloomy, and the market is weak and cheap. Emotionally, this is easier said than done, and it is not easy fighting your cautious instinct. That is why, getting invested and staying invested through a balanced, globally diversified portfolio with a significant weighting to equities has consistently given clients a much better chance of preserving and growing their wealth throughout different economic cycles.

Your RetiremeantTM Specialist and Investment Consultant always take these factors into consideration when structuring your investments.

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