From my Citywire column yesterday….
It will probably surprise most Citywire readers, but I do actually read many of the comments after my regular columns. Obviously, I welcome plaudits (!), but it’s the questions that I tend to find most interesting. A few weeks back one reader quite rightly asked why I hadn’t explored one absolutely crucial issue facing many advisers with wealthy clients – the cautious obsession with cash. In truth, it is something I’ve been aware of for many years and has ever so slightly puzzled me.
As investors get older, they have a tendency to grow more cautious. But equally likely is that as they grow wealthier, they also grow more cautious. Put together both trends and wealthier, older investors can frequently end up with huge cash piles which stay inactive for many years. I am sure this peculiar state of affairs drives their advisers to despair because the hard facts suggest that the opposite strategy makes sense. So, to be clear, I can see why a wealthy investor in their mid-seventies will be mid way through the de-accumulation process and weighting their assets towards safety, with cash a large component of that portfolio. But what many advisers actually see is investors in their mid-fifties holding cash as high as 25% to 50%. Cue much shaking of professional heads. Wealthy investors in their mid-fifties are HIGHLY likely to live into their eighties if not older (increased wealth begets increased longevity, on average). Thus, they can afford a higher risk budget, with equity possibly comprising as much as 50 or even 100% of their allocations, depending on personal circumstances of course.
At this point older, wealthy investors, mired in zero yielding (in fact negative if we take into account inflation) cash, counter that they’re worried about market risk i.e exposure to stock market turbulence. And of course, on paper, they are right to be worried about this risk. Stocks are volatile and declines of 20 to 40% are not uncommon. Again, some rough and ready rules are that if you might need the cash in say 3 to 5 years, then equities might not be a great place to invest – bonds and other alternatives might have their uses. But once that time horizon moves out past first five years, and then ten years – and possibly even further out – then equities can, and have, made a huge amount of sense (assuming past data is relevant – which is all we have to base any analysis on).
At which point another concern rears its head.
What happens if I time that investment in stocks poorly? Assume you have a lump sum that you are starting to invest (which isn’t likely to be the case with most older, wealthier investors who probably already have some equity exposure), you could pick quite possibly the worst weeks and months to deploy the cash stash – and then see markets plummet. As I said already, markets are indisputably volatile and one could easily mount an argument for being worried about current valuations – even equity enthusiasts such as myself are hugely cautious and tactically choosing to run more cash than usual.
But the hard numbers, based on historical data, tends to tell a different story. Timing markets is largely a fools errand and in many, if not most cases, if you have a long enough time horizon (at least five, if not ten years), then even if you pick the worst possible moment to invest, you’ll probably still be better of with equities compared to cash. But there is one important caveat which is that you need to be diversified in that equity exposure.
Let me explain with some concrete examples. I looked at data for the S&P 500 and the FTSE 100 since 1987 and in addition prices for the FTSE All World index since 2003. In each case I threw up a chart and then picked a peak level (the tip of a chart within that year) and then looked at returns ten years after that interim peak. In the case of the FTSE All World I shortened that to five years after the interim peak. For the S&P 500 I counted 16 peaks – where the index had hit an interim high before falling back sharply – while in the FTSE 100 I counted 12. For the FTSE ALL World I counted 17. In each of these cases, you’d have been timing your equity investment disastrously – picking the exact wrong moment to invest. But in my scenario, you were patient and sat tight for five to ten years.
The result? With the S&P 500 in 13 out of 16 examples, you’d still have made a net gain, in most cases a very substantial gain. In the example of the FTSE All World, you’d have been ahead in 14 out of 17 cases, down in just two, and basically unchanged in one example. But there’s the rub. In the example of the FTSE 100 you’d have made a loss in 8 out of 12 cases and a gain in just 4. This dismal data reminds us why the London index is such an outlier in terms of returns and value. Its cheap and has been for many years.
I’m in the process of running a similar analysis for a few other benchmark indices and so far, the data tells a similar story. If you’d have been patient, you’d be making a profit even after having picked a terrible few weeks when markets peaked. But you needed to be diversified i.e not just investing in UK stocks.
As I have said until I am blue in the face in these columns, global diversification is hugely important. Don’t just slink back into your UK focused perspective and think the world revolves around Blighty, it doesn’t. Diversify, be patient, cut fund costs and in most circumstances an equity investment makes sense – whereas cash is a guaranteed to lose its value after inflation.
So, to return to my initial point. All those wealthy, older investors – what the hell are doing running so much cash? What do you know the rest of us don’t?