What are the hidden costs of hoarding cash?

The impact of inflation means that the real return on cash savings is often disappointingly low

Despite seemingly high interest rates on savings accounts, the real return on cash has been negative for most of the past four years due to inflation. Antonie Robertson / The National

In an era where traditional savings seem increasingly secure, it is crucial to understand the hidden costs associated with hoarding cash.

Despite high interest rates offered by banks, the reality of inflation means that the “real” return on cash savings is often disappointingly low.

As we look ahead, exploring non-cash assets might prove a more lucrative approach for the coming decade.

The illusion of high returns

There was a time when saving meant simply depositing money in the bank and enjoying a decent return.

However, the landscape has shifted dramatically. Despite seemingly high interest rates on savings accounts, the “real” return on cash has been negative for most of the past four years due to inflation.

This erosion of value underscores the necessity of exploring other avenues for investment.

Diversifying beyond cash

For those wary of risk, cash may seem like a safe haven. Yet, its comfort can be deceptive. Holding a lot of cash probably means you are conscious of risk.

Multi-asset funds could be a viable alternative, offering a balance between risk and return by diversifying investments across various asset classes, including stocks, bonds, real estate and commodities.

Why a multi-asset strategy is important

Multi-asset funds provide exposure to different sources of potential returns. For instance, stocks, particularly those in sectors like consumer staples and energy, can be resilient during inflationary times. Conversely, consumer discretionary and technology stocks might falter when economic belts tighten.

Commodities, known for their price volatility, often rise with inflation and can serve as a hedge against losing purchasing power.

Bonds, ranging from low-risk government bonds to higher-risk emerging market bonds, also play a pivotal role in many investment strategies. Their performance can vary with changing interest rate environments, making them a critical component of a diversified portfolio.

Stocks are another key component of a balanced investment strategy. During inflationary periods, companies making essential goods, often classified under consumer staples, tend to perform well because demand for basic necessities does not wane.

Energy stocks also typically hold their ground as energy remains a fundamental need regardless of economic conditions.

On the other hand, during times of economic contraction, consumer spending on non-essential items tends to decrease.

This shift impacts consumer discretionary sectors, which includes luxury goods, non-essential services and technology, where investments are often seen as expendable during tough economic times.

Long-term investments are key

The value of a long-term investment strategy often surpasses attempting to time the market.

Historical data suggests that staying invested typically yields better results. Market fluctuations often tempt investors to time their trades, but missing even a few key days can significantly reduce potential returns.

If you invested in global equities, missing out on just the 10 best days in the last 20 years could cut your returns by half.

It is a formidable challenge to predict these days accurately, and frequent trading increases the risk of missing them.

For those who find the management of investments daunting, outsourcing to professionals via actively managed funds might be an appealing option. This allows individuals to leverage expert knowledge in market trends and risk assessment, potentially enhancing the performance of their investments.

Embracing discomfort for greater returns

Investing involves not just steering clear of discomfort but strategically embracing it to secure a sound financial future.

Opting for safe, low-return options might spare some sleepless nights, but it won't necessarily set your portfolio up to achieve long-term financial security.

Diversification, particularly through bonds and multi-asset funds, not only spreads risk but also enhances the potential for real growth.

When every dirham counts, making your money work as hard as you do is not just an option, it’s a necessity.

For investors looking to navigate the complexities of modern finance, understanding the real costs of cash and the benefits of diversified investments is key.

The future belongs to those who are prepared to embrace a little discomfort for substantially better returns.

Fabio Faltoni is product director of multi-asset strategies (MAS) UK team at Invesco