Thinking cash? Think again

PORTFOLIO POINT: Have you got nerves of steel when it comes to your super fund’s investments? Thinking of switching to cash? Yesterday’s rate cut should put a dent in that plan.

In this bear market that is creeping on a year old – if you start the timer at the peak close on November 1 last year – those with nerves left are having them severely tested.

Many lost their will to reason long ago. It might have saved them a small fortune. Others are just holding on, fearful of missing any rebound. And judging by the email correspondence being received by Eureka Report’s Supersecrets desk, there are many, many more who just don’t know whether they should be holding on to the last of their wits or not.

There is a near complete lack of confident in investment markets. And boring old cash is looking like a better option every day. Well, that was until yesterday.

Now the Reserve Bank’s panic-like 1 percentage point cut very quickly removed much of the premium return attraction of cash. If you, like dozens of Eureka Report readers who have been driven to write in, were seriously thinking about giving in and moving to cash, read on for why you probably shouldn’t.

The following email is typical. “I retired in September 06 and have investments with Colonial Super with an allocated pension that has lost $50,000 in the last 6 months. Should I withdraw and invest in a term deposit or sit and wait in the hope the value returns to the stockmarket before I lose all my money. Very concerned and would appreciate advice.”

Variations on the theme of that email come from those who are approaching retirement – that is, within a few years. There seems to be an acceptance that the losses that occurred in January and even February were acceptable. That was just taking back some “irrational exuberance”. But the market has fallen from around 5700 points in February down to a low this week of a touch below 4400 points. It has been those losses that have been the straws causing concerns for the already struggling camel’s back.

In many respects, there’s an air of resignation swirling. The questions essentially boil down to this: “I don’t know if I can take any more of this market in freefall. Should I bite the bullet and move to cash, where the returns will at least be positive and reliable?”

For a start, you won’t lose all your money. Even the biggest bears don’t believe stock markets, as we know them, will become worthless. But today, we’ll have a look more deeply at what those people who are asking that style of question need to consider, because it is concerning so many readers.

There’s no easy answer and there’s certainly no single answer to that question. It depends on your investment time frame (which is longer than you probably think), your ability to sleep at night and how you’d feel if you lost another, say, 10% of your super.

It appears that SMSFs trustee investors were faring better – according to what readers were tellingTrishPowerinJune– than the average (balanced) managed super fund, which lost 5-8% in the year to June 30.

But things have only got worse since June 30. The All Ordinaries has fallen from 5332 points on June 30 to below 4400 points. That’s a further fall of more than 15%. As of that point on Monday afternoon, the All Ordinaries is down 35% from the close on November 1. International shares are doing nearly as poorly. And while the worse appears to be over for commercial property – which was also down around 36-40 per cent at one stage – it’s a case of don’t count your chickens there yet either.

The average fund invested 100% in growth assets (shares and property) are probably down around 30-35% now, as of the close on Monday. There will be readers in that position. There will also be readers who are feeling quite good about themselves because they have received 7% or so in the last year by being completely in cash.

First, let’s have a look at where super funds were as at Monday afternoon/Tuesday morning, before the RBA’s cash rate cull. We’ll assume all growth assets (shares and property) are off 35% and we’ll assume that income assets (cash and fixed interest) grew by 7.5% over the course of the last 12 months. Below is a table that shows what the returns would be like with six types of investment style, from all cash “conservative” to an all guns blazing, 100% growth, investment strategy.

Table 1: Estimated performance of investment styles from the top of the equities cycle.

(These figures ignore dividends and so are a little unfair to growth assets, but we’re talking a few percent here over the course of a year.) This is simply to show that unless you were heavily overweight cash – predominantly cash – you are likely to have been on a hiding to nothing over the last 12 months. Those returns mailed out following June 30 were actually good news for super funds to be sending out. If they were sending them out now, there might be rioting in the streets.

Given this, what about cutting your losses, switching to cash and waiting out the storm?

If you really can’t handle it anymore, then that might be your only choice. Some of the letters coming in have said that were talked out of switching to cash by advisers because it would “crystalise losses” and because “markets bounce back”.

Both statements are accurate. But they’re not the main reason that you might want to stick around in equities. We’ll come back to that.

Certainly, going to cash will protect your capital. (However, this is based on the assumption that banks don’t start falling over and taking depositors’ money with them, which is possible, if considered unlikely, for Australian banks.)

There are other reasons that moving into cash now (Jamie, ‘now’ bolded or italicised, please). It’s that dictum about chasing returns. Chasing the best performing managed fund from one year to the next is accepted to be a flawed strategy (though it will never stop investors doing it). But the same rule applies to individual shares and asset classes.

Cash was just pipped into second spot in the league table of assets in the 2006-07 financial year, according to Lonsec’s annual wrap, which compares six asset classes: cash; Australian fixed interest; international fixed interest; Australian shares; international shares; and property.

While cash has been a great performer recently, that’s almost certainly gone now. While it’s possible that it might still be the best performer in the 2008-09 financial year, the return won’t match the returns of cash in 2007-08 year. After four increases to the official cash rate from the Reserve Bank in the 2007-08 financial year, returns were quite reasonable. It wasn’t difficult to get a return of more than 7.5%, even above 8%, for your cash investment. (Returns for cash-based investments are never as good inside managed fund super as can be achieved by SMSFs who can chase deals directly.)

The RBA cut once in September and then blew everyone out of the water yesterday. Direct interest rates and term deposits will come off as a result, very, very quickly. The outlook for cash returns will not get better from here in. They could fall substantially.

Have equities bottomed? Who knows?AlanKohlerdoesn’t think enough bargains have reared their heads yet. Even the experts – including Eureka Report’s highly credentialed Market Bottom Assessor team – have failed to see the bottom to the equities market.RobertGottliebsenwrote recently that he didn’t think we’d seen the classic “day of no hope”. (Although we might begin to pray that that was Tuesday morning …)

Could it fall another 10%? Another 20%? Anything’s possible. If you want to read two opinions of what the world would look like if the All Ordinaries fell to 3500 in 2010, read the pieces byGerardMinack(link) andScottFrancis(link) from July. (If anything, I’d tend to side withScott.)

Many of the concerns being raised by readers are completely understandable, but very short-term, concerns. “It’s hurting now, so how can I make the pain go away?”

For a start, look at your current super account balance. Now, take away another 10%. How would that new number make you feel? If you’re reaching for the anti-nausea pills, then you have an issue. This is a possibility in the short and medium terms. Long term, it would seem unlikely. If you took your super and added just 5.5% to it (not including contributions), would you be happy with that? That’s roughly where you’re likely to be in a year’s time if you’re in cash.

If you want to stay in equities, from now on, every time you look at your super fund, take 10% off it. Assume that’s all you’ve got. It’s bearish, but it’s possible. If the thought of that happening terrifies you or makes you break out in a cold sweat, then perhaps you should investigate lightening up your super equities exposure and moving some more of your money to cash.

At this stage of the game, psychology becomes more and more important.WarrenBuffettis buying. His well-known mantra is to be greedy when others are fearful and be fearful when others are greedy. If we’re not seeing fear now, despair almost, then we’re in for some unpleasantness of a scale that hasn’t been seen for many decades. Is he right (accepting that he’s buying companies in a different part of the world, with different fundamentals)?

Now, let’s talk about the upside. What’s the danger in switching now? As with the reader above, do you want to change the horse, the jockey or the race that you’re on?

I don’t know so much that changing super managers (jockeys) matters. If you’re in managed fund super, go for well-established super managers. Don’t chase the one most recently on top of the tables. Do you want to change the horse (growth versus income assets)? Potentially. These can be changed considerably (by going from an 80-20 fund to a 40-60 fund, for example).

Or do you want to change the race that you’re betting on? The race that you’re on comes down to whether you’re betting on a sprint or a distance race. But, remember this, it’s not about how long until you retire. It’s about how long you’re going to live.

If you’re the average Australian male, you’re going to live to approximately age 79. If you’re female, you’re going to live to 84. If you’re currently 60, you’ve got, roughly, two decades left. While Australians are good risk takers prior to retirement, they tend to be far more conservative in retirement (see my article on February 1 this year).

Given that, let’s assume things bottom out now. Or soon.

What happens if “normal” markets resume operation. By normal, we’re not talking the 20%-plus returns we experienced in Australian equities for about four consecutive years to October 30 last year.

We’re talking the numbers in the table below. They again come from Lonsec and look more at the long-term averages (and are, you would think, reasonably conservative).

Table 2: Growth of $100,000 over seven years.

These are the sorts of figures that drum out the noise of year to year. These figures aren’t too far off the market if you look at asset classes, if you look at Lonsec’s tables for the 18 years toJune 30, 2008. This is a far more likely scenario to look at in October, 2015 (seven years from now). This is, to me, a far more comfortable prediction to make than where the All Ords is going to be in October 2009.

The Australian market is down 35%. International equities are down considerably. Property seems to have largely taken its medicine. It’s been very painful. The end of the pain may not be for some time.

It’s hard to block out some noises. But the market gyrations of this year are simply not normal. We know that.

Nobody knows where the end of this is for sure. But if you want to take the chance that you’ll get out at the bottom, then be aware of the upside you might be giving up.

And for those chasing cash returns … the Reserve Bank just handed out a reality check on that front yesterday.

Bruce Brammall is a senior financial adviser with Stantins Financial Services.