How can cash ever be "King"?

[Jamie]

Hi all,

Something Ive been thinking about lately, and this great thread started by topcropper especially got me wondering.

How can "cash" ever be King?

There seems to be a general consensus that at some stage of the investment cycle, cash is the best asset class, offering better returns than either shares or property. I just can't understand why...

Lets use the example of $100,000 (not borrowed) to use for investment in any asset class. If you invest in cash, the most you can hope to earn is around 7% - so your return for investing in cash is a completely unleveraged $7,000 per annum.

Is it just me, or would this sort of return be completely unacceptable for most people here? Even ignoring rental yield/dividends, this is the same ROI as capital growth of 3.5% pa on shares leveraged at just 50%, or 1.4% pa on a property leveraged at 80%.

How many people here would back themselves to buy a property this year that will increase in value more than 1.4%? Or buy shares that return more that 3.5% per annum?

If the money is borrowed, the situation is even more pronounced. Investing in cash returns less than the rate you're borrowing at - how can this ever be acceptable? Interest rates are going nowhere - there is as much chance that the next rate movement will be down as there is that it will go up, and low inflation is here for the foreseeable future.

Im assuming Im missing something here. In this economic environment, how can "cash" ever be King?

Jamie

 

[Aceyducey]

Jamie,

King is relative based on the return.

In an economic climate where shares, businesses and property are stagnate it's feasible that a 7% return on cash is the best achievable.

However the fact that it isn't that type of environment right now is something that people forget while practicing their mantras.

It's good that you've picked up this fallacy as it's very common for all humans to fall for simple mantras and models and pursue them vigorously even when reality doesn't match.

It's one of the reasons I've often advised people in the forum to check their own assumptions. And I check my own ALL the time.

Cheers,

Aceyducey

 

[agent007]

My 2 cents here,

The way I see it, cash is “king” only when the supply of cash is being taking out of the “system” like during the great depression. If the supply of money is limited and one can’t change assets into cash in order to either service debt or pay for goods and services then, it is understandable why those who has the cash are “king” since they can take our assets for nothing or next to nothing. From the point of view of investment per se, I agree with you. Cash can’t be king at all.

Regards,

James.

 

[GreatPig]

Jamie,

this is the same ROI as capital growth of 3.5% pa on shares leveraged at just 50%, or 1.4% pa on a property leveraged at 80%.

Those figures are assuming that rental returns and dividends are enough to cancel out the loan interest. If the interest rate was 7%, then you'd need about a 5.6% rental return after costs and a 3.5% dividend return to do that (with the borrowing levels you mention). Not sure how easy the former is now, but I don't think the dividend return should be too difficult.

I think cash can be king in uncertain environments just because it's safer. Unless the bank goes broke, you can't get a capital loss, whereas it's quite easy with property and very easy with shares. And I would imagine that the primary reason investors turn from property and stocks to cash is for just that reason - to lower the risk on their capital in uncertain times.

In other words, it's more for managing risk than maximizing returns.

GP

 

[duncan_m]

Unless the bank goes broke, you can't get a capital loss

Inflation erodes cash in the bank.. so on paper maybe no capital loss, but unless interest matches inflation a loss occurs.

 

[Kris Sheather]

How about 'good debt is king', or 'leverage is king'.

 

[markpatric]

I think it all comes down to risk, time and motivation, there would be a point where you may not see money as the be all and end all and pursue other interests.....hope so anyway.

This point may come when you`ve reached a certain financial comfort zone or you have some kind of crisis in your life, as we all do at some points.
It`s got to be a good thing to have money in the bank......just for the sake of it.

 

[GreatPig]

Inflation erodes cash in the bank

True, but then inflation needs to be allowed for in the growth figures for property and shares too.

Cheers,
GP

 

[NigelW]

Hi all,

Something Ive been thinking about lately, and this great thread started by topcropper especially got me wondering.

How can "cash" ever be King?

There seems to be a general consensus that at some stage of the investment cycle, cash is the best asset class, offering better returns than either shares or property. I just can't understand why...

Lets use the example of $100,000 (not borrowed) to use for investment in any asset class. If you invest in cash, the most you can hope to earn is around 7% - so your return for investing in cash is a completely unleveraged $7,000 per annum.

Is it just me, or would this sort of return be completely unacceptable for most people here? Even ignoring rental yield/dividends, this is the same ROI as capital growth of 3.5% pa on shares leveraged at just 50%, or 1.4% pa on a property leveraged at 80%.

How many people here would back themselves to buy a property this year that will increase in value more than 1.4%? Or buy shares that return more that 3.5% per annum?

If the money is borrowed, the situation is even more pronounced. Investing in cash returns less than the rate you're borrowing at - how can this ever be acceptable? Interest rates are going nowhere - there is as much chance that the next rate movement will be down as there is that it will go up, and low inflation is here for the foreseeable future.

Im assuming Im missing something here. In this economic environment, how can "cash" ever be King?

Jamie

When you need to buy some groceries???

You have to maintain a certain amount of liquidity to pay for expenses both planned and unexpected but also to be able to quickly take advantage of any opportunities that present themselves.

Perhaps the best way is to have the cash drawn but sitting in your offset...

Your point is very good one though.

To digress for a minute I just cannot understand why anyone with any borrowings would invest in "cash" particularly through the medium of a managed fund... Why pay some gouging fund manager 1.5% to put some of your money into bonds yielding 6%??? You can get that from the bank yourself... what the???

Cheers
N.

 

[demoman]

Tradies

Hi,

I've come across a lot of tradies who reckon "cash is King".

Cheers

Jared

 

[gregss]

My understanding is that if inflation is negative (i.e. during a recession), the value of assets (shares, property) falls in relation to cash. You are better off having the $100K than having bought a $100K house or some shares that are now worth $90K, $80K, ....

I'm not sure how rent comes into it but in a recession (depression?) presumably your rents are falling too.

My greatest appreciation goes to the Reserve Bank for keeping inflation in the preferred band. May they keep it there for a long time to come.

 

[MarkB]

Inflation erodes cash in the bank.. so on paper maybe no capital loss, but unless interest matches inflation a loss occurs.

True, but then inflation needs to be allowed for in the growth figures for property and shares too.

GP, I am not sure if you are saying:

a) That inflation does erode the value of property and shares (as it does with cash),

b) That inflation does not erode the value of property and shares, or

c) Something else completely.


But....

When cash is invested at X%, that X% is represents (before allowance for CPI) the sum total of both the expected growth in the asset base and the income stream to be generated.

Every dollar you spent of the income (net interest earned) effectively erodes your asset base in real terms (and vice versa).

However, for both shares and property asset base and income streams are delineated.

You can spend every cent of your income (be it net rents or net dividends) and rest at night knowing that (if history is any judge) over the course of the business cycle your asset base (the value of the property or the shareholding) will outperform CPI.

In addition, for property, rents should at least be indexed to CPI.

Mark

 

[GreatPig]

Mark,

a) That inflation does erode the value of property and shares (as it does with cash)

Yes, that one.

Every dollar you spent of the income (net interest earned) effectively erodes your asset base in real terms (and vice versa)

I really don't see the difference: return is return, whether it's capital or income in nature (although of course the tax treatment is different).

Earning 6% interest on money in the bank, or 3% capital growth on a property with 3% net rental income, is the same return (ignoring depreciation and other taxation differences). If the 3% rental return goes to paying off loan interest, then that would be the same as spending half of the bank interest received on cash and leaving the other half to compound.

On the plus side for cash though, there's no hassle with tenants, PMs, and vacancies, and lower costs (no land tax or stamp duties).

and rest at night knowing that (if history is any judge) over the course of the business cycle your asset base (the value of the property or the shareholding) will outperform CPI.

I think that depends on your time frame and the state of the property/share cycle at that time. I believe there have been whole decades of almost flat growth in property values in the past, although I don't know what the CPI was during those same periods. If your time frame is 20+ years, then maybe you can rest fairly comfortably, but if your time frame is less than 10 years, then at a time like right now there may be more cause for concern.

And if you've negatively geared the property, the growth rate has to exceed both the CPI and rate of interest losses to stay ahead.

Cheers,
GP

 

[Merovingian]

I think that depends on your time frame and the state of the property/share cycle at that time. I believe there have been whole decades of almost flat growth in property values in the past, although I don't know what the CPI was during those same periods. If your time frame is 20+ years, then maybe you can rest fairly comfortably, but if your time frame is less than 10 years, then at a time like right now there may be more cause for concern.

And if you've negatively geared the property, the growth rate has to exceed both the CPI and rate of interest losses to stay ahead.

Interesting you mention this. I wonder if in these economic conditions, property producing a positive cash flow each week would be more abundant, (and hence a different drive in investing would be apparent).

 

[Panic]

Jamie,

Here are my thoughts on when cash is king?
1. Liquidity
2. Low rental yields (less then 6%)
3. Economy stagnating or contracting, and property going backwards in CG
4. Owning a business which needs cash infusions occasionally
- Do not consider cash as only AU$, think about other currencies and possibly gold as well.

Thx
V

 

[GreatPig]

Interesting you mention this. I wonder if in these economic conditions, property producing a positive cash flow each week would be more abundant, (and hence a different drive in investing would be apparent).

I think in the end the overall return has to be sufficient to make investing in property viable. In a low growth environment, rents would have to be higher to compensate (other things - like interest rates and taxation - being equal). Thus more likelihood of cashflow positive properties.

GP

 

[MarkB]

When cash is invested at X%, that X% is represents (before allowance for CPI) the sum total of both the expected growth in the asset base and the income stream to be generated.

One more thing on that....

It is an indisputable fact that if you have cash invested, to protect the real value of your capital you need to put aside some of your income earned.

If the money is borrowed, the situation is even more pronounced. Investing in cash returns less than the rate you're borrowing at - how can this ever be acceptable?

It is also highly likely that money invested in cash is not leveraged (as Jamie notes - the rate of interest on a loan is greater than the interest paid on cash invested).

But something that I cannot see has been discussed in this thread is the taxation implications of cash investments.



Consider $100k invested at 7% pa ($7000), with CPI at 3%.

In this case, $3000 of your interest must be added back into your $100k or else your capital base is reduced.

So, $7000 in income, of which $3000 goes back into your capital, and you have $4000 to live off.



Wait a moment.....

Every cent of that $7k was taxable income and in 2005/06 - supposing you earn AWE or thereabouts (around $40k) - your marginal tax rate is 30%.

So, $7000 in income less $2100 (30% of $7k) in tax and $3000 back to the capital base, leaves you (with a pissant) $1900 (1.9%) as a return on your $100,000 "investment".

Woohoo!



So, unlike either shares or property - both of which have (as mentioned) distinct capital growth and income features - the sustainable (ie. protecting real value) management of cash investments requires that you re-invest from pre-tax income and, as a result, net returns are severely reduced.


Mark

 

[spark]

As was mentioned earlier, cash can be a very good asset in a deflationary environment and (looking globally) during the appreciation of the currency in which that "cash" is denominated.
Eg: for 1Mil AUD you may buy now a better/more property/cars/electronic gadgets than a year ago. Same is when for 1Mil AUD you may buy more Euro/CHF than a year ago.

Another thing is the yield - getting those "sure" 6% without any expenses is better than many current rental yields, and in many cases than dividends. And you are not exposed to "value" changes.

Of course you cannot leverage cash in the same currency, it is stupid, but you can punt on other currencies...

But, to my opinion the saying "cash is king" deals with its total liquidity and immediacy - it is immensely easier and swifter to TRANSFORM cash into ANY other asset class than vice versa . This is the "King" virtue of the cash - you can do ANYTHING and you can do it NOW.

 

[GreatPig]

unlike either shares or property - both of which have (as mentioned) distinct capital growth and income features

Capital growth certainly has more favourable tax treatment, in that it's not taxed until it's realised and then possibly with the 50% discount.

However, as I mentioned earlier, sometimes that capital growth may be negative, which is much more difficult to do with cash provided it's invested in reasonably secure institutions.

So, $7000 in income, of which $3000 goes back into your capital, and you have $4000 to live off.

Then try a $500K property geared at 80% (ie. $100K deposit, $400K loan) with 7% interest. Growth is 3%, income after costs (except interest) is 4%, and CPI is 3%. This matches your 7% return with 3% CPI.

Loan interest = $28K
Inflation-adjusted growth = $0
Income = $20K
Overall result: $8K loss

How can you live off that?

GP

 

[MarkB]

Then try a $500K property geared at 80% (ie. $100K deposit, $400K loan) with 7% interest. Growth is 3%, income after costs (except interest) is 4%, and CPI is 3%. This matches your 7% return with 3% CPI.

Loan interest = $28K
Inflation-adjusted growth = $0
Income = $20K
Overall result: $8K loss

How can you live off that?

If that is the best IP deal that you can find (even in a post-boom Australian market), then I suggest that you are not looking hard enough or, alternatively, that you stick to term deposits.

I could have used a ludicrous example as well, such as someone who dumps their $100k in a cheque account paying about .25% interest pa, but I chose not to.

Mark