Cash as king is dead. Where to now for the folding stuff?



Index investing with cashWith a world of investment opportunity out there … why would anyone focus their attention on interest rates on savings?

Why? Sadly, because everyone still needs to hold cash. As a result, interest rates, as pitiful as they are, become important for at least a portion of anyone’s wealth.

I emphasise “portion”. I’ll come back to that.

Chasing rates now is as fruitful as life is for a mouse running around an exercise wheel. Except way less funny. Mouse and cat videos are entertaining. Stuffing around to get an extra poofteenth on your money … is not.

Interest rates for savings currently top out at about 3 per cent. Moving your money from one provider to another usually requires time filling in forms and, potentially, physically or electronically moving your cash around institutions.

However, given the bonus interest rates that tends to accompany these products, moving your money around every couple of months is crucial to actually receive some sort of return.

But let’s take a step back … earning interest rates in a savings account is almost a fruitless exercise. At best, you’ll earn around 3 per cent.

The average income earner is going to lose more than a third of that in tax (between 34.5 and 39 per cent). Let’s call that 1.95 per cent. With inflation at 1.5 per cent, your savings are “growing” at, rounded to the nearest whole number, nothing.

There may be better options than this merry-go-round. For at least some.

For those with a home loan, the offset account is by far the place to hold your cash.

Offset accounts work because you pay no tax on money that is saved. So, if you’re saving money at 3.8 per cent (because that’s your home loan rate), take off inflation at 1.5 per cent, you have an after-tax return of 2.3 per cent.

That’s still pathetic. But 2.3 per cent is about five times better than 0.45 per cent. Yep, that’s how much better offset accounts are, in the current interest rate environment.

Everyone needs to hold some cash, at least for emergency money. As a float for the self-employed.  To save for a new car, holiday, wedding or a buffer for maternity leave. Or simply to pay your home loan off faster.

Why is cash important in times of low interest rates? Clearly, it’s not about the returns. It’s about safety.

Whether you are earning 1 per cent, or 3 per cent, on your savings is actually secondary to the security. You know it can’t go backwards. It can’t be lost. Your capital is safe. (Thanks to government guarantees.)

All other assets outside of cash pose some risk to your capital. Shares and property obviously. But also “safe-ish” investments, such as bonds.

So the real decision when it comes to cash and interest rates is actually how much of your money do you need to be purely safe?

Then, how much are you prepared to take at least some risk with in order to, hopefully, achieve something greater by way of returns?

Got me?

Long-term returns for shares show that in great years, it can return 40-50 per cent. Bad years can return -30 to -35 per cent. On average, however, they are likely to outperform cash.

And between shares and cash, you have property and fixed interest. On average, they will also perform better than cash. But they will have good years that are way better and bad years that are, well, pretty crap.

The point. Keep what you need to keep in cash. For some, that will be everything, because it is the deposit for the house they hope to buy in the next two years.

For others, it isn’t. They bought a little while ago, are comfortable with the mortgage repayments, and are ready to start creating real wealth outside of the family home.

When you hit that point – being comfortable that you can deal with the mortgage – that’s the time to start investing. Whether that is inside or outside of superannuation, or a combination of both, is a topic for another day.

Cash returns are at the bottom of their cycle. Keep what you need in cash and safe. But if you’ve got more cash than you really require … start to consider your longer-term investment plans.

Bruce Brammall is the author of Mortgages Made Easy and is both a financial advisor and mortgage broker. E:

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