The cash conundrum

Cash is a terrible ‘investment’. As far as I’m concerned it isn’t one -though there appears to be one period over which it outperformed the FTSE100 TR. If you were dumb enough to sit on a shedload of cash and invest it all in one go in December 1999 then you’d have been better keeping it as cash for 15 years. Well, yeah, but who saves for a pension in cash over half their working lifetime, chucks it all on red and then goes home? If you are such a soul, you deserved all you get. Most of us save for a pension as we earn, albeit at varying rates through our working lives. In general, if you suddenly have a whacking great lump like that you haven’t earned it, so tough luck if you came into an inheritance in late 1999 and blew it all into the dotcom bust. Easy come, easy go…

£100 will remain £100 but won’t be worth £100 as time goes by

In theory private investors can give up part of their lives to moving cash about between the latest best-buy accounts for years. You’ll be working hard for a lousy return, but at least no volatility.

Cash is not an investment. It is a mediocre store of value but a great medium of exchange

At the moment, interest rates are low. There is a lot of grousing about this, which I don’t have a huge amount of fellow-feeling for. I have never regarded cash as an investment. It’s a proxy for a claim on work in the future, and medium of exchange. It is crystallised power. It is symbolism, it is not procreative in itself. It still surprises me when people think they can get a real return on cash.

The stories your parents told you about saving cash and it growing were largely a lie. They were right that if you add £1 a week you end up with £52 after a year, it grows as you add to it, rather than in and of itself. You still have to work for that. If you want it to grow in value by itself, well, that, indeed, is why you invest. Indeed, the story of the talents I was taught at school is a much more accurate portrayal. If you want your wealth to grow you have to put it to work in doing something. Merely digging it into the ground, sticking it under the mattress or putting it into a bank account isn’t good enough. You can put it to work in the stock market, you can put it to work in a BTL house portfolio, you can put it to work in building a business or buying productive capacity, be that training of yourself or machinery and plant to make better widgets. All of these need skill and judgement calls, and involve some element of risk because what you think should happen doesn’t always happen. There be dragons.

If you want relative security of cash, it ain’t gonna grow – you will largely be running down your capital in retirement. There’s nothing wrong in that. It is what I am doing at the moment. It is what an annuity does. Everybody panics when they think of not getting an income. They want the security that the number at the bottom doesn’t change without their say-so. Clearly they’ve never read Lady Windermere’s Fan, in which Oscar Wilde summarises the problems of conflating price and value,

a man who knows the price of everything and the value of nothing

In doing that they miss that the value of that number slowly degrades with time, but that’s a different story.

So what’s all this cash doing in my portfolio then?

Cash is not an investment. It dies quietly in the night, slip-sliding away one tiny bit at a time. Unlike my fellow Britons of the grey hair I am happy with low interest rates as long as they go along with low inflation. When you see that the majority of my liquid assets are in cash you can see why.

over 50% cash, WTF? (The SIPP and AVCs are in cash)

This doesn’t show my house, land holdings and main pension savings, but otherwise represent my financial status. For someone who spends so much time grousing about how crap cash is that a fellow PF blogger couldn’t resist the temptation to poke a sleeping Ermine with a stick about how well cash had performed over  the last 15 years I sure hold a lot of it.

By the way, the mad asset allocation needs breaking out into 2/3 HYP and 1/3 something that will eventually look like the VGLS100 mix, but I want to buy the components when they’re cheap. I believe valuation matters. There is a big slug of The Firm’s shares gumming up the works I bought as Employee Share Incentive Plan (easy way to avoid paying 40% tax and get at it in 5 years not retirement age) and sharesave humping up that UK large cap pie. I am limited by CGT to running that out into something more diversified and in my ISA. So it’s ugly compared to the delightful balance of RIT’s portfolio. A HYP where you don’t sell grows in a gnarly and lumpy fashion. If you want neat and tidy, buy a total world equity index tracker and spend the rest of your time on the golf course. They look after pruning the lumpy bits for you.

I hold a lot of cash because I am an anomaly. I am poor and wealthy at the same time

Let’s just nail high-level definitions here. I am not a Russian oligarch and I’m not worth a million pounds, okay. I am nowhere near the 1%. As Philip Greenspun said, people vastly overestimate the networth of early retirees because they are anomalous. One of those anomalies may be they spend less than most! The ONS, bless them, summarises the difference between income and wealth well.

The difference between wealth and income

Total household income is a flow concept, and refers to the incoming flow of resources over time. […]

Total household wealth is a stock concept, and refers to a balance at a point in time.

That said, I am not in the left-hand side of their Fig 2. I have no income – the ONS counts investment income but I reinvest mine. The Joseph Rowntree Foundation tells me I am poor despite living like a king. Everything in a modern industrial economy qualifies people by their income, and so a financial institution would pull up my credit files and flag up in red “this mustelid is a destitute deadbeat. He must be sleeping under the railway arches. Don’t even think of advancing him credit”. I haven’t had to punch The Man’s clock for two and a half years now, there’s not too much hazard of that in future, I got to wonder what the hell is this bad boy looking at me in the Suffolk sunshine yesterday while most folk were doing an honest day’s work, but I am apparently boracic lint.

What are you looking at, hawk? Kestrel I guess, but I am no good at hawks, and he wasn’t doing the stationary hovering in the air thing.

I have the existing credit cards I had from when I was working. I wanted to raise some cash recently, to help someone over a short-term shortfall. I struggled to borrow money even though the amount doesn’t really show on this chart. It’s the stock and flow difference, I didn’t want to pull this out of my Cash ISA or NS&I and I had ISA allowance to make up, so I had stock in the wrong place and frozen, and needed flow. It wasn’t emergency enough to break into NS&I if it could be borrowed. I’ve got all this wedge back, it did its job, it now lies uselessly in some bank accounts (I’ve knocked the value of the loan off the cash balance, natch). To a large extent, other than about £10k, I am locked out of credit. Nobody will give me a mortgage, the bank wouldn’t consider me for a loan, I am an unperson. They probably wouldn’t give me a mobile phone contract if I wanted one. I did wonder if I would struggle to change electricity providers. People who have no income but are not destitute are rare in 21st century Britain. There aren’t that many pre-55 FI retirees in Britain, leastways not enough for the financial system to find it worth qualifying for advancing flow against their stock.

And that is why I hold so much cash. Credit is the engine of a consumer economy, and it is a reasonable thing for somebody younger than me still working to take the Jacob ERE line and say “emergency fund? I don’t need no stinkin’ emergency fund, I have a credit card for that”. He has human potential. I don’t have human potential I can count on – I am over 45 😉 So I have to be able to pay cash in an emergency.

When I left work I designed my emergency fund to address emergency across five years or so. So far it hasn’t happened. But I have no ability to raise funds and I can’t pay down any emergency from earnings. Above all else what I want from cash is liquidity. That means no term accounts, it excludes Zopa because you can’t get money back from them very fast, it excludes all sorts of wheezes that people who believe cash is an investment use to slow its dissipation into thin air.

So what’s all that cash in my SIPP/AVC then, surely that’s nuts?

I saved up almost exactly 25% of the nominal value of my DB pension is AVCs. This was targeted at the 25% tax-free PCLS. I did that before Osborne’s pension changes, and I couldn’t use any increase because there is an asymmetry if I take stock-market risk – I would lose 20% of any upside to the taxman and have to annuitise it anyway. Any downside I’d eat 100% of. For a period of five years, I figured I’m not having that. I will eat the roughly 10% loss of value as cash. I saved 42% going in and made about 20% while it was in the stock market. Sometimes you gotta lose some battles in the interest of winning the war.

Osborne’s kind of shaken this all up, and it may make sense to shift some of that AVC into my SIPP and run the sucker flat over a few years before taking my main pension. Dunno. Will see what happens this April and May. The stock market is high at the moment anyway, if we had a worthwhile correction I might be tempted to nut 20-40% of that cash into the market.

The Ermine is my banker of last resort, and liquidity is king

Liquidity above all else is what is prized in the banker of last resort. He doesn’t have to shoot the lights out in terms of paying a return. His value is in being last man standing when the emergency comes, and he needs to be able to pay.

As soon as I get a pension income I am going to treat cash with the contempt it rightly deserves as an investment and shift a load of this into equities. I hold so much cash now because I need instant liquidity – the Ermine is my banker of last resort at the moment, and in a credit crunch liquidity trumps ROI. I won’t be a forced seller of equities under most likely conditions because of this cash; later on when I have an income I won’t be a forced seller because I will use the income from equities, and in a push could probably do without that and use other income. if there is one thing I have learned about the stock market (it applies to the leveraged housing market too) it is Be No Forced Seller.

Forced sellers get a bum rate on their assets – pennies on the dollar. Don’t be one

The money you could earn on cash in a productive asset class is the insurance premium you pay to avoid being a forced seller. Like all insurance it’s a deadweight cost. Until you need it…

The reason I snarl about cash is I know how bad an investment it is from the worry this has given me 😉

Inflation worried me no end a couple of years ago, I was wrong, as it happens. Now people are stressing about deflation, unlike nearly everyone else I could probably use any deflation offered. I was preparing to eat the loss of a lot of money. As it was I was lucky and dodged that bullet, and soon I will have choices about reallocating it. That’s the trouble with cash – you take on a shitload of worry in return for serious amounts of liquidity. In the end the way the government pays for all those promises we vote for but don’t want to pay tax for by salami slicing the value of the pound in your pocket, they slice a teeny little bit out of it every single day.

In the end it’s our own fault, because we refuse to have a grown-up conversation about how to pay for all the goodies we want though don’t need, so inflation is the only way the poor devils can square the circle. And that, dear readers, is why cash is not an investment. If you’re going to dedicate so much of your life to wheezes attempting to keeping the value of your cash, then why not try and get your head around the reason why investment is better in the long run and get a better return for your time and trouble? I’ve gained more in dividend return (ignoring capital gain) by paying attention to investment than I’ve lost due to the cash rotting despite cash being the larger part of my total portfolio. You have to continuously shift your cash from pillar to post to get decent rates, you’re still almost bound to lose the fight over a period of 30-40 years.

The other reason cash-boosters are wrong is scale. It is relatively easy though tedious to get a decent return on a modest amount of cash – you can get good inflation-beating rates on £5000 or less rate-tarting it about. Try doing that on an order of magnitude more and up and all of a sudden you have a lot fewer options open to you. NS&I were an easy win here – you leave a hoard with them on index-linked savings certificates and you get to come back a few years later and you have a hoard that is roughly the same value without all the rate-tarting, worrying about whether you are investing the the new Icesave or whether you will feel like the Three Bears when you come back for your porridge and find somebody’s eaten it all.

People tell me this was different in the past and maybe it was, but it hasn’t been for any part of my experience of having a notable amount of cash. The past is a foreign country: they do things differently there, among them paying you real interest on cash. I used to be able to turn a return on other people’s cash by stoozing – credit cards would lend me up to £15k without interest or fees and Nationwide used to look after this paying me interest. Been a long time since that was possible, too.

Cash is okay over five years usually. Not so much over 50 years

Let’s hear it from Warren Buffett

During the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, generated the overall return of 11,196 per cent.

‘Concurrently, the purchasing power of the dollar declined a staggering 87 per cent. That decrease means that it now takes $1 to buy what could be bought for 13¢ in 1965 (as measured by the Consumer Price Index).

‘There is an important message for investors in that disparate performance between stocks and dollars…The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency.

The American market is probably better than ours, but in the end it’s a variant of the tale of the talents. If you want to hoard a store of value then maybe gold is a better bet, though our Warren doesn’t rate that much better – to wit

“neither of much use nor procreative”

Cash is useful, but unproductive, unless you’re prepared to open shedloads of current accounts. Take this Telegraph reader who put the legwork in to stow £70,000 in 11 accounts to win £1800 a year. Unless she has specific reasons to need massive amounts of liquidity that seems to be a tough way to stay just ahead of inflation. Yes, she’s realising 2% more than me – about £1400 p.a. I’ve given that up on the equivalent part of my cash, but my ISA cost me a lot less than her £70k and is worth more (at the moment) and in dividend income alone beats it into a cocked hat – and being an ISA no further tax to pay. Not only that, but if I leave it damn well alone it’ll very likely do similar next year, whereas the Telegraph reader is going to have to close a load of accounts and open a load more, just to stay in the same place. The reason she has to work harder than I do is because cash, while of much use is not procreative. It is a so-so store of value and an excellent medium of exchange. Getting more valuable just by sitting there is not part of its job description.