Fresh Thinking Channel

Look after the pennies....

So the old proverb goes, and the pounds look after themselves.  When it comes to investing it’s all about balancing an acceptable risk against a projected return, for your individual circumstances. It is on this principle that our long-term approach to disciplined and diversified financial planning is predicated. All too often, however, investors tend to err on the extremes – either dismissing cash as an authentic asset class, viewing it instead as merely a means of exchange, or devoting excessive importance to it, at the expense of a diversified portfolio including other (riskier) asset classes.

Investment decisions are governed by our appetite for risk and even the most cautious investor, because of the low risks and low returns associated with cash, is usually on the lookout to deploy capital. However, such an approach runs the risk of under-allocation to cash because there are stages in market cycles when cash may well be one of the most attractive asset classes out there. Excessively increasing one’s portfolio allocation to cash, on the other hand, also exposes the investor to undue risk. It may be that investors wish to wait for the price of what might be considered riskier assets to come down thereby making them more attractive and potentially viable investment alternatives. But the diversification principle of portfolio management recognises that markets often move in unpredictable ways, and excessively high allocation to cash at the expense of other asset classes, in expectation of lower prices in those latter asset classes, may work against investors if those asset prices move higher.

In truth, cash, is very much an asset class and should be an intrinsic part of any portfolio. Just as a truly diversified portfolio moves to tactically over-allocate and under-allocate – but never completely exit – other asset classes, so too should investors tactically adjust their cash holdings to over- and under-allocation positions based on their assessment of its attractiveness relative to other asset classes.
Money talks. And in an environment where stocks, bonds, property and, more recently commodities, are struggling to retain their value, the real value of cash, because of its relative stability, lies in its ability to provide options. Should prices of other asset classes come down, cash can provide a  platform from which to snap up any potential bargains.

Many savers agonise over their stocks and shares on an almost daily basis, neglecting their savings simply because of the apparent lack of risk and the lack, in general, of much of a fiscal reward. But there is an argument that one way to help protect your portfolio is to keep a very close eye on your savings, make them work as hard as they possibly can for you, and hold onto them until attractive and compelling value opportunities elsewhere prompt a portfolio re-balance away from cash and towards relatively more attractive asset classes.

While interest rates and inflation do not currently shine kindly on savings, past performance, while no indication of future performance, has shown, as you might expect a generally more stable asset.

Obviously within a shorter time frame other asset classes are likely to easily out-perform savings but in doing so they will be subject to peaks and troughs. And at such times, the smart investor, who has patiently and carefully managed their savings, could find that having looked after the pennies, they will be in a position where the pounds may well look after themselves.