With equity markets down 15-20% so far in 2022 and increasing financial press coverage of the possibility of a recession on the horizon, some investors are taking the approach of moving a large proportion of their assets into cash, both to mitigate further losses and to position themselves to start buying back into the markets when the outlook has started to improve. However, trying to time markets accurately is next to impossible and can prove costly over time, as we have examined in our previous article ‘When cash isn’t always king, but still an important part of your investment portfolio’. But with inflation soaring, is holding cash in your portfolio beyond your emergency fund the right strategy?
The problem with cash at the moment
With inflation in Ireland now expected to surpass 6% in 2022 and interest rates remaining very low, leaving money in cash is a sure-fire way to reduce your wealth. I recently read a quote from Ronald Reagan who said, “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman.” Inflation is certainly no friend of the saver, who will see its purchasing power eroded at a faster rate than we have been used to for some time, over the coming months, and possibly even years. Historically, and if as recently as the early 2000s in Ireland, savers and investors would have received interest on their cash deposits that would have provided some protection against rising prices. However today, with surging inflation, and interest rates only starting to return to positive levels, any interest received on deposits is insignificant when compared with inflation.
Some cash still makes sense
Cash plays an important role as part of your overall investment portfolio, or personal balance sheet. It provides liquidity, for any unexpected requirements, or to avail of investment opportunities, and is also the ultimate safe haven, at least up to the levels of the government-backed deposit guarantee scheme, which protects deposits of up to €100,000 in any single institution. It always makes sense to retain a certain amount of cash as an emergency fund – we typically recommend that investors have immediate access to approximately 6-9 months of expenses in case unforeseen events should arise. Cash has the benefit of being accessible immediately in the event of an emergency. So, while any cash assets will undoubtedly suffer a loss in value after inflation, it is often sensible to have access to some cash.
So how can I protect my assets against inflation?
It is important to understand there are no silver bullets. Look at the asset mix of your investment portfolio and understand the role of each asset type. Over the long term, equities and property have traditionally offered the best protection against inflation. But in the short term, they are higher-risk investments than cash, as their values can fluctuate and can deliver negative returns for extended periods of time. Most assets perform poorly during times of high inflation, and slowing economic growth, but anybody looking for positive returns needs to accept a degree of investment risk. Diversifying your investment portfolio can provide a degree of protection against this while offering the potential to earn a return that can keep up with the effects of rising prices over the long term. Some investments and assets may be better for the job than others.
Being clear about your investment timeframe is an important first step when developing your asset mix. Any money that you may need to use in the short term should not be invested in assets that might fall significantly in value over that time. Next, you should understand your tolerance for risk. Some people can comfortably live with short-term volatility in their portfolios when they have a long-term time horizon. However, others are not so calm in the face of swings in the value of their portfolio. This latter group may require a lower risk approach that gives them a smoother investment return, with the consequence that their returns are likely to be lower over time. Investors typically seek to maximise their returns, while doing so at a risk level that matches their own tolerance for risk.
Inflation, like sudden market falls and economic recessions is another risk that investors need to plan for, as it is generally bad for investments, as well as increasing your future needs. It is important to ensure that your investment plan has taken account of inflation and that both your plan and your asset mix match your time horizon for investing, your risk tolerance and your financial situation, so you can navigate through choppy waters along the way. Though you will not be able to avoid inflation completely, taking steps to plan for it and protect your portfolio from it may mitigate some of its impacts.