By Nirdev Desai, Head of Sales, PSG Wealth

Many investors are currently sitting on the sidelines of the market – holding cash reserves while waiting for better investment opportunities. National Treasury notes that household deposits in banks in South Africa exceeded R1.7 trillion in 2023, which is about three times higher than what has been the norm since the inception of this measurement, and this trend can also be observed in global markets.

Warren Buffett of Berkshire Hathaway wrote in his latest annual letter to investors that they’re struggling to find good investment opportunities and are sitting on piles of cash themselves. When these are the words of arguably the most respected value investor, it’s a good indicator that there are many others who will be sitting on cash – waiting for better opportunities to invest in growth assets when the time is right.

If you intend to include cash holdings in your portfolio, then it’s critical to acknowledge that cash is not always a failsafe option, and that guarantees are (at best) only as good as the word of the guarantor. So it’s important to understand these risks and how to mitigate them.

What constitutes cash?

When used to describe an asset class, the word ‘cash’ includes assets that range from short-term deposits (15 days’ notice) to bonds with longer-term maturity dates (typically 10 to 30 years). Fixed-income instruments can also be differentiated by their different coupon structures and varied terms on capital certainty. Lastly, fixed deposit assets are offered by banks, and by corporates through credit. The quality of these investments can vary greatly, so it’s crucial to seek out skilled asset managers who have received industry recognition for their fixed-income management capabilities and ability to construct well-diversified portfolios that cater for specific client needs.

The risks associated with cash and how to mitigate them

Single counterparty risk

It is typical for a bank, for example, to lend to the market against its own book. This book comprises, amongst others, deposits invested in the banks by investors. The risks associated with investments with a single counterparty, such as a bank, is thus that investors only get exposure to the quality of the book lent out by a single institution and that investments are linked to lenders being able to pay back their loans and the institution being able to manage these obligations sustainably.

Risk of defaults

While cash assets offer less market volatility than equities, they also carry the risk of defaults and ‘haircuts’ (which refer to reductions applied to the value of assets, expressed as a percentage). Several banking institutions have come under the spotlight over the last few years, both locally and abroad. One of the larger banks in the US (Silicon Valley Bank) defaulted in 2023, and 13 South African banks defaulted in the 30-year period prior to 2018, so defaults are not as rare as many investors may think.

What protection do investors have?

If a bank defaults or is unable to cover its liabilities, its ability to pay back depositors is stressed and depositors will have to work on terms to get their deposits back. Locally, the South African Reserve Bank’s Deposit Insurance Scheme offers a backing for depositors, but this insurance is limited to R100 000 and is claimable on a case-by-case basis.

What is the solution?

Hold cash for the right reasons

It is wise to hold some cash for emergencies, and a prudent guideline for this is three times your monthly income. Surplus cash reserves should be diversified appropriately to mitigate exposure to single counterparties and to achieve exposure to different kinds of cash assets, such as negotiable certificates of deposit (NCDs) and different grades of debt. PSG Wealth’s view is that it is prudent to have less than 7.5% of your investment exposure allocated to a diversified portfolio of cash, with cash for emergencies and any other known liabilities that will need to be covered over the coming six months invested in a transactional facility.

Consider cash in your financial plan

Ensure that you have a holistic financial plan, and that cash is considered as part of it. It is important to ensure the right exposure to the correct asset classes for the appropriate time period to achieve the most reliable outcomes for your cash flow needs. Time in the market is critical, and ensuring you don’t unnecessarily hold too much cash gives your money time in the market to work for you.

To specifically cater to clients’ cash management needs, address the concerns listed above and ensure cash holdings are included as part of its comprehensive financial planning process.

Recently, PSG Wealth expanded its offering to cater to our clients’ need for cash reserves. The PSG Wealth Cash Account is designed to mitigate the risks described above and complement a holistic financial plan. It caters for a range of competitively priced cash needs, with attractive rates through a spread of cash duration opportunities and diversification. It also allows for quick allocation to market opportunities when the time is right, and is fully liquid in case clients need access to their cash for other needs. Speak to a financial adviser to ensure your cash is optimally managed to meet your cash flow needs.