Money in the bank is essential to meet ongoing spending and current liabilities on time. It’s also important to have access to liquidity for unforeseen expenses and events. Given the rise of interest rates and increased investment opportunities in fixed income markets, exactly how much cash one should keep on reserve is back in the spotlight.
The exact amount of money in the bank needed will, of course, vary by individual preferences and circumstances. It would appear however that many households and businesses appear to hold far more than the standard six months of expenditure that is frequently identified as needed in a stress scenario. In other words, they may hold excess cash, beyond what is required for liquidity and security purposes.
Taking this precaution may simply be human nature. Most people will try to avoid risk and forego some return for security. Irish retail bank deposit rates are currently still low, so it is worth exploring what options may be available to investors to maintain liquidity and benefit from a more positive expected return. This is particularly important at times when inflation remains high, to avoid erosion of purchasing power.
Depositors with excess cash (beyond immediate liquidity needs) should keep the following considerations in mind:
1. Take time to carefully consider what you or your business’s current and future cash requirements may be – and err on the side of caution. A secret of success for any investment plan is the ability to stick to that plan through good and bad times. Talk to your financial planner or investment adviser to move this forward.
2. Cash holding beyond immediate transactional needs should receive some interest. As wholesale interest rates are no longer negative, it is now possible to hold cash or near-cash while receiving a positive and indeed non-trivial return, without taking on unwarranted market or credit risk.
3. For cash that may be required to meet future liabilities or unforeseen circumstances, make sure that the liquidity and security of the investment is matched to that requirement.
4. If you identify cash that is truly excess, beyond transactional and precautionary needs, think about what its ultimate purpose may be and discuss with your financial adviser a suitable investment plan to make the most of its future value.
So, what options are available for investment of cash, without taking on inappropriate levels of risk with capital that needs to stay reasonably liquid?
At Goodbody we take a graduated, step by step approach that starts with an assessment of current cash holdings and considers a range of options for different risk profiles and time horizons.
Switching some portion of excess cash balances to highest-grade, short-dated government bonds should appeal, whether in custody holdings or via simple fund form. Gross yields of near 3% are currently available on AAA-rated short-dated (less than one-year) euro government bonds. For corporates, where sustaining capital value may be the principal consideration, this approach is often the most suitable. Term bank deposits are also an option but are less liquid.
A little more risk
For larger amounts beyond transactional needs and where some variation in capital value is acceptable, another option is positive-yielding, short-maturity fixed income portfolios. Such a portfolio can be constructed of primarily high-grade, short-dated government and corporate securities – with a small share of other diversified credit risks to increase yield further as desired. A conservative blend of credit exposure can currently generate a gross yield of near 4%, with relatively low market and credit risk in a portfolio context.
Extending the time horizon
The higher-risk alternative for truly excess cash balances is a blended investment portfolio of equities and bonds. While equities alone are a higher-risk part of the capital structure, prone to occasional but significant drawdowns, a well-balanced investment portfolio has a high probability (based on historical data) of preserving value and potentially adding significant growth over a five-year-plus time horizon.
It is a good idea for investors to review why they hold cash, how much is needed, and what risks you are exposed to – and then to consider what options exist to diversify, avoiding capital erosion, preserving purchasing power and potentially pursuing capital growth.
No commitment, complimentary consultation
To avail of a no commitment, complimentary consultation with one of the team on options that might work for you and your circumstances, please contact Owen Redmond at [email protected] and we’ll be in touch.