Is Cash Still King?

Federal Reserve officials continue to give signals that they will be moving to rate cuts soon, possibly in September. The market is now at a turning point and fixed income investors may be wondering what are the best options to pursue? Is cash still king and being liquid the best move for investors now? Hoarding cash and waiting may seem like an optimal move for some, however cash may soon be dethroned if locking in higher yields and maximizing returns is your ideal goal.

There is an opportunity cost to holding cash. While all investors should have emergency funds that are liquid, holding excess cash may be detrimental. It’s best to have only enough cash for emergencies, to meet upcoming obligations or if you have an opportunity that will materialize in the short term. When interest rates are falling, yields on cash such as savings accounts and money market funds normally decrease. This means that the returns on cash would be quite low. By holding cash, investors miss out on potentially higher returns available through fixed income securities.

In a declining interest rate environment, cash is not the only thing that will soon be dethroned if higher yields are what you are looking for. Short- term investors should also be cognizant of reinvestment risk. Short-term instruments require frequent reinvestment as they mature. In a declining interest rate environment, each time you reinvest, it will more than likely be at lower prevailing rates. This reinvestment risk can erode overall returns and over time reduce your investment income. Longer-term investments, on the other hand, allow you to lock in favourable rates for extended periods, thus lowering the frequency of needing to reinvest and its associated risks. So consider opting for a 1 year repurchase agreement instead of a 30 day one, and if you can go even longer, then consider global bonds.

Another thing to consider is that today’s price is not yesterday’s price. In a declining interest rate environment longer term assets also present the potential for capital appreciation. New instruments will invariably be offered at a lower rate. As rates fall the price of existing bonds tends to increase. This is because the fixed interest payments from these bonds become more attractive compared to the new lower-yielding bonds issued at reduced rates. As a result, investors currently holding bonds may see an appreciation in the value of their investments. For the investor who moves later to purchase longer dated securities, the prices will likely be higher thus reducing your overall return.

Short term instruments by their nature are typically less volatile and present lower risk however the tradeoff for this is limited growth potential and a lower return. For a fixed income investor these lower returns may not be sufficient to meet your long-term financial goals. Diversifying your portfolio with a mix of short- and longer-term assets over different sectors will enhance your portfolio and produce stability. Longer term assets will also give you a fixed income stream to plan ahead in a changing environment.

While holding cash or short-term instruments might seem like a safe choice with the least risk, it’s not always the most effective strategy in a declining interest rate environment. With rate cuts on the horizon, shifting from short-term liquid instruments to longer-term investments can provide numerous benefits.

Before making any major changes to your portfolio, it's crucial to consider your personal financial goals, risk tolerance, and investment horizon. Speak with your licensed advisor about how best to align your portfolio and to meet your financial needs.

Christine Rankine is Assistant Vice-President -Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm

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