Why is cash so important and where does it stand among our investments?
It is often said that cash is king, and the idea of being flush with money has been portrayed as the ultimate pipe dream. Cash does rule everything around us, infiltrating every aspect of our lives while inspiring everything from art, movies to even music: Think The O’Jays’s For The Love Of Money (yes, that ode to dollar bills popularised by the Donald Trump fronted reality show The Apprentice), ABBA’s Money, Money, Money or even Jessie J’s Price Tag.
But when it comes to investing, there is such a thing as having too much cash. In that instance, consider parking your money into assets, as that could give you a better return than cash itself. Cash, on the other hand, is also seen as a life-buoy, especially during rainy days. You want to have enough cash — or liquid funds — on hand so you are not forced to sell any assets you have at a loss in times of need.
But first, what is cash?
Cash is fiat money or currency that is not backed by a commodity such as gold. It is also legal tender used as a means of exchange. It can come in the form of dollar bills and coins. Cash exists in the form of various currencies backed by the governments of the different countries on the globe. In terms of investments, cash is seen as part of your reserves. It is a tool to help plan your assets, a means to an end.
How much cash do you need before investing?
Before putting all your cash into investments, you should set aside a sum to tide you through in the event of an emergency. A general guide would be to have at least six months worth of your ongoing expenses.
When should you put your money to good use?
When you do not need them urgently, when your debts are paid and when you have excess cash to spare.
See also: Fuelled by China’s promise: Golden opportunity for Hong Kong SDR investing
How does it factor into your investment portfolio?
Cash, on its own, will not help combat inflation. In fact, it is a victim of inflation. When you have got money in excess, the last thing you want to do is to squirrel all your dollar bills under your mattress. Apart from an actual fire, inflation and exchange rates are your biggest enemies. In short, if you had $1 million from a decade ago, the same amount will not be worth as much today.
This is why you will need a certain amount of cash to put it into assets that offer you decent returns. One of the ways to future proof your money is to invest it in shares, commodities or property. Should you prefer something that is more liquid, there are other alternatives such as a savings account, money market securities, foreign exchange (forex) trading and fixed deposits.
When should you hold on to more cash?
When there are no properly undervalued stocks in the market at the moment. Or, if the universe of stocks that are suitable based on an individual investor’s risk tolerance and capacity are overvalued, that’s when investors should hold on to their cash first.
The best thing to do is to re-evaluate the stock you’re looking at and set upper and lower boundaries. If a counter falls to a price that is trading at cheap valuations, that’s when it’s time to buy. Otherwise, you should just wait or average down very conservatively.
If you are projecting that a crash is very near or if a crash is going to last longer than expected, that’s when you should consider putting your money into safe-haven assets like gold or bonds.
For more stories about where money flows, click here for Capital Section
In addition to the six months’ worth of expenses, you’ll also want to have extra cash such that you’re able to buy into deals whenever the opportunity arises. That excess money is also what investors call “dry powder”.
Cash as an asset class
There are several ways to trade cash as an asset class. A few examples include forex trading and money market trading.
. Forex trading
Forex trading refers to the exchange of one currency for another currency. That way, you will gain profits when the currency you have bought increases against the other.
For instance, the US dollar to the Singapore dollar is now trading at an approximate US$1 to $1.38. Should the US dollar strengthen to a rate of US$1 to $1.40, for instance, you would have gained $20 for every US$1,000 you bought.
Forex markets also tend to be one of the largest and most liquid assets in the market due to its global reach. All trades take place electronically over-the-counter (OTC), there is no one central marketplace for forex deals.
Due to its cross-border nature and reach, forex trading can take place round the clock, which means prices can change constantly. There is an element of volatility when you’re trading the forex markets too.
Just like commodities, forex is used as a means of diversification. It is also seen as a good hedging tool, especially in the event where you don’t want your currency to fluctuate wildly assuming that there’s geopolitical uncertainty.
On its own, the global currency market is not a volatile one. Looking at the past five years, currencies are trading at a range of between –7% to nearly 17% (see Chart 1).
To enjoy more returns, some traders look to leverage trading. More losses may also be suffered should things go south. For instance, if someone is trading on 10x leverage, the range would be between –70% to 170%.
The returns on forex trading are generally affected by macroeconomic factors, as currency movements are usually caused by governments.
. Money market
This is a place where banks, brokers and financial institutions trade short-term funds. In Singapore, such funds invest in short-term fixed income instruments such as government and corporate bonds, commercial bills and deposits with financial instruments. Such short-term instruments usually mature within three to six months.
. Savings account
Having a savings account has become so commonplace we do not often see it as a form of investment. Yet it is considered a form of investment as your money accumulates some interest, even if the interest consists of a small amount per annum. Putting your money into a savings account may be low risk, but there are still certain risks involved, no matter how small.
In Singapore, there is the Singapore Deposit Insurance Corporation (SDIC) that covers individuals and other non-bank depositors who have placed deposits with a scheme member under the SDIC. Non-bank depositors include sole proprietorships, partnerships, companies and unincorporated entities like associations and societies.
The deposits insured by the SDIC are Singapore dollar denominated and placed in current, savings and fixed deposit accounts. Monies placed under the CPF Investment Scheme, the CPF Retirement Sum Scheme, the Supplementary Retirement Scheme and other prescribed products are also covered: Amounts are insured for up to $75,000.
Scheme members include all full banks and finance companies in Singapore such as the three local banks, DBS Group Holdings, Oversea-Chinese Banking Corporation (OCBC) and United Overseas Bank Limited (UOB).
What are near-cash assets?
- Near-cash assets are the second easiest asset class that can be converted to cash.
- Savings accounts: One of the most basic financial products where you deposit money into a bank for a small amount of annual interest.
- Fixed deposits: These are similar to savings accounts except that there is a minimum sum required to put into a fixed deposit. The sum is then locked up for a certain period of time in exchange for a higher interest rate upon its maturity.
- Money market securities or money market funds are products that are low-risk and mature in a shorter amount of time, usually below one year. These are benchmarked against the interest rates for bank deposits. Examples of money market securities include Singapore dollar denominated debt securities, US dollar denominated debt securities and debt securities denominated in other currencies that are tradeable in Singapore dollars.
- Certificate of Deposit (CDs). These are similar to fixed deposits, in which they’re like savings accounts that restrict your access to the money you put for a period of time in return for a higher interest rate. Unlike fixed deposits (FDs), CDs are freely negotiable.
Foreign currencies
These are the top traded eight major currencies of the world
- US Dollar (USD)
- Japanese Yen (JPY)
- Chinese Yuan (CNY)
- Euro (EUR)
- British Pound (GBP)
- Swiss Franc (CHF)
- Canadian Dollar (CAD)
- Australian Dollar (AUD)
Key words
- CASA: Current account savings account. These are non-term deposits. A current account is one which is used for business transactions. A savings account is where savings are deposited and interest is earned.
- Dry powder: Excess cash or cash reserves that are kept on hand for future purchases or acquisitions. This may also refer to marketable securities that can be converted into cash at any time.
- Fiat or fiat money: Money that is issued by a country’s government that is not backed by any commodity.
- Liquidity: This refers to how quickly a product can be converted into cash.
