{"id":647,"date":"2016-07-22T16:44:59","date_gmt":"2016-07-22T23:44:59","guid":{"rendered":"https:\/\/chaltenadvisors.com\/blog\/?p=647"},"modified":"2016-07-22T16:44:59","modified_gmt":"2016-07-22T23:44:59","slug":"the-most-dangerous-asset-class-may-just-surprise-you","status":"publish","type":"post","link":"https:\/\/chaltenadvisors.ca\/blog\/the-most-dangerous-asset-class-may-just-surprise-you\/","title":{"rendered":"The most dangerous asset class may just surprise you…."},"content":{"rendered":"

Investors flee to cash during times of trouble. \u00a0However, far from being a safe haven, cash is potentially\u00a0the most dangerous asset class for investors, luring investors into bigger psychological bubbles than even tech stocks and housing\u00a0have historically.<\/span><\/p>\n

We recently wrote about why investors might want to consider holding bonds rather than cash, even at current\u00a0low and negative yields (see<\/span> Why on earth would you hold a bond with a negative yield?<\/a>)<\/span><\/em>. \u00a0A recent article (see<\/span> Journey of Cash<\/em><\/a> by Alex Gurevich) and further investor questions have inspired us to think\u00a0a bit more specifically about\u00a0cash and its merit (or not!) as an asset class\u00a0in a well diversified portfolio.<\/span><\/p>\n

Hold cash for known near-term purchases and an emergency fund<\/strong><\/span><\/p>\n

First of all, before we start thinking about cash’s merits as an asset class, let’s be clear about something. \u00a0Holding a certain amount of cash is prudent\u00a0– it should be held in safe, liquid instruments and for two purposes:<\/span><\/p>\n

    \n
  1. To fund\u00a0known near-term purchases (mortgage down-payment, next year’s college tuition, etc) and;<\/span><\/li>\n
  2. To be set aside as a reserve to be used in the case of an emergency (house repairs, surprise periods of unemployment, other\u00a0unplanned expenses, need to help a family member, etc) \u00a0We usually recommend an emergency fund somewhere between 3-6 months of fixed and discretionary living expenses depending on your specific situation.<\/span><\/li>\n<\/ol>\n

    Beyond for personal consumption, cash is not useful as an asset class\u00a0<\/strong><\/span><\/p>\n

    Beyond the two\u00a0purposes stated above, investors should consider the merits of\u00a0cash as an asset class alongside the other asset classes in their portfolio\u00a0like stocks, bonds, real estate, commodities, etc. \u00a0As an asset\u00a0class, rather than as a means to fund personal consumption, cash leaves a lot to be desired. \u00a0Some of the specific shortcomings are well understood while others\u00a0less so:<\/span><\/p>\n

      \n
    1. Holding cash leaves you susceptible to inflation risk – when inflation exists, the nominal value of your money loses purchasing power over time – who remembers when a chocolate bar cost a quarter\u00a0and taking the bus cost a dime? \u00a0People generally get this point.<\/span><\/li>\n
    2. Cash offers poor investment returns – cash equivalent investment vehicles like GICs and money market funds offer returns that hardly keep pace with inflation. \u00a0This is also broadly\u00a0understood.<\/span><\/li>\n
    3. The opportunity cost and risk of holding cash is high, especially if held in one currency – when investors use cash as an asset class, not only do they miss out on other potentially more productive investment opportunities, they often hold it in their home currency, \u00a0If this isn’t money we need to spend in our home currency, why hold it in only\u00a0our<\/span> home\u00a0currency? \u00a0 As Canadians have witnessed recently, currencies can be quite volatile\/risky even though they don’t offer a high expected return over the long run. \u00a0Holding cash increases opportunity cost and exposes investors to specific currency risks. \u00a0This point is less well understood.<\/span><\/li>\n
    4. Using cash as an asset\u00a0class is usually done in conjunction with trying to time the ups and downs of the market and market timing is extremely difficult. \u00a0People are terrible at market timing yet investor funds-flow data suggests they try time and time again unsuccessfully to pick market tops and bottoms.<\/span><\/li>\n<\/ol>\n

      Cash is used for market timing and market timing doesn’t work<\/strong><\/span><\/p>\n

      This last point is worth expanding. \u00a0Investors remember well the stock market highs around the tech bubble in the early 2000’s and in 2008 just before the financial crisis cut stock markets\u00a0in half, causing investors enormous short-term pain. \u00a0But who remembers these crashes\u00a0in terms of the “cash bubble” that followed immediately afterwards? \u00a0While the climb-downs from the peaks\u00a0were painful, in many cases they weren’t nearly as painful as the damage caused to investors who fled to cash near the bottom of the equity market and remained in cash through the subsequent recovery. \u00a0Holding cash is an active investment decision and\u00a0these “reverse bubbles” (missing out on the upswings) do just as much or more damage to long-term investor returns. \u00a0Investors went to high levels of cash in 2008\/2009 and many investors have stayed out of the market since then even though many stock indices are once again near all time highs. \u00a0Furthermore, \u00a0investors that cashed out at the bottom never actually benefited from being in the market\u00a0during\u00a0the peaks (except for an unrealized gain on\u00a0paper) but they did realize actual poor investment returns when they sold at the bottom. \u00a0Unfortunately this\u00a0cycle repeats itself every time fear starts to creep into the market.<\/span><\/p>\n

      Canadians no exception<\/strong><\/span><\/p>\n

      While not exactly the bursting of a bubble, at the end of January this year Canadian stocks hit their lowest point since mid-2013. \u00a0And sure enough, many investors panicked and Canadian cash held by investors hit a record (see CBC’s report at the time:\u00a0<\/span>Canadians hold record $75B in cash as they wait out volatile markets<\/a>). \u00a0<\/em>Unfortunately for many investors, these record cash levels coincided with the market bottom. \u00a0Since then the recovery has been swift, Canadian stocks have jumped back up approximately 20% leaving many cash laden investors wondering what happened and hesitant to come back into the market at these levels.<\/span><\/p>\n

      The reason cash is so appealing as an asset class is exactly the reason it is so dangerous. \u00a0Investors flock to it en masse<\/em>\u00a0when it’s too late and cling to it as a safe haven during times of heightened fear. \u00a0The problem is investors remain anchored to the traumatic feelings\u00a0that forced them to flee the market\u00a0in the first place. \u00a0There they remain frozen, unable to act and as a result\u00a0miss out on any\u00a0subsequent recovery as the market shakes off the correction and\u00a0adjusts\u00a0back to\u00a0its long-term job of earning return on capital for risk takers. \u00a0Market timing is so dangerous because it requires that you make not just one good call on the market (when to get out) but a second, even more difficult\u00a0call (when to get back in). \u00a0People, even institutional investors, are\u00a0just not hard-wired to make those calls effectively.<\/span><\/p>\n

      To reiterate, it is prudent to keep enough cash on hand to fund\u00a0near-term known purchases and your emergency fund, otherwise, keep this dangerous asset class to a minimum.<\/span><\/p>\n

      \u00a0<\/span><\/p>\n

       <\/p>\n

       <\/p>\n","protected":false},"excerpt":{"rendered":"

      Investors flee to cash during times of trouble. \u00a0However, far from being a safe haven, cash is potentially\u00a0the most dangerous asset class for investors, luring investors into bigger psychological bubbles than even tech stocks and housing\u00a0have historically. We recently wrote about why investors might want to consider holding bonds rather than cash, even at current\u00a0low […]<\/a><\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1,16,15],"tags":[],"class_list":["post-647","post","type-post","status-publish","format-standard","hentry","category-all-posts","category-asset-allocation","category-risk-and-return"],"_links":{"self":[{"href":"https:\/\/chaltenadvisors.ca\/blog\/wp-json\/wp\/v2\/posts\/647","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/chaltenadvisors.ca\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/chaltenadvisors.ca\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/chaltenadvisors.ca\/blog\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/chaltenadvisors.ca\/blog\/wp-json\/wp\/v2\/comments?post=647"}],"version-history":[{"count":4,"href":"https:\/\/chaltenadvisors.ca\/blog\/wp-json\/wp\/v2\/posts\/647\/revisions"}],"predecessor-version":[{"id":651,"href":"https:\/\/chaltenadvisors.ca\/blog\/wp-json\/wp\/v2\/posts\/647\/revisions\/651"}],"wp:attachment":[{"href":"https:\/\/chaltenadvisors.ca\/blog\/wp-json\/wp\/v2\/media?parent=647"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/chaltenadvisors.ca\/blog\/wp-json\/wp\/v2\/categories?post=647"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/chaltenadvisors.ca\/blog\/wp-json\/wp\/v2\/tags?post=647"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}