What is the cash asset class?
The cash asset class is made up of cash in bank fixed deposits, as well as securities that can easily be converted into cash. These securities are often referred to as cash-equivalents.
These instruments are issued by governments, banks or parastatals that pay interest and include:
These cash instruments typically do not have a term – they are on call – or they mature in less than a year. Many of these instruments may be traded in the money market, but those investing in the cash asset class may use bank deposits as well as money market instruments. Read more: What is a money market fund?
How do investors make money in cash?
Cash investments pay interest and typically the longer the term to maturity, the higher the interest the security will pay.
Why do fund managers invest in cash?
Portfolio managers use cash for a variety of roles in a portfolio, including:
Investing in cash along with other asset classes provides diversification. There are times, particularly when interest rates are high, that cash will outperform all the other asset classes.
Over the past 93 years to the end of 2022, cash outperformed the other asset classes 12% of the time, according to Old Mutual’s Long Term Perspectives.
Investing in cash provides stability in a portfolio – cash investments are not volatile like the other asset classes.
Cash is also highly liquid, so managers can park money in cash while they look for better opportunities, and move it quickly when these opportunities arise.
Many investments, like unit trust funds, need to have some cash holdings – around 5% of the fund - in order to quickly pay out investors who want to withdraw. Other securities like shares may take time to sell.
The drawbacks of investing in cash
The biggest disadvantage of investing in cash over longer periods is that it will, on average, only outperform inflation by a small margin.
It is not a good idea to hold a large proportion of cash investments in a long-term investment, like one for your retirement, because it will not give you the growth you need.
Depending on how you invest in cash, you may also pay tax on the interest that is paid.
As an individual, you can earn a certain amount of interest tax-free each year, but beyond that, you will be liable for tax on the interest at your marginal tax rate. Check the annual interest exemption in our Tax Tables and read How do the income tax brackets work and what is my marginal tax rate?
Unit trust funds that hold cash earn interest and pay this to unit trust investors as interest. This must be declared for tax purposes, unless you are invested in the fund through a tax-free savings account or retirement fund.
Cash is trash or cash is king
Asset managers often refer to cash being trash or cash being king. Mostly they say cash is trash because, over the long-term, it does not outperform inflation. But in recessions when both bond and equity prices are falling, the cash asset class will do better and then cash will be king.
