The invisible pitfalls of cash investments

Feel free to reach out to PSG Wealth Manager  HW de Jager  directly.

When people talk about cash investments, they usually refer to savings accounts, fixed deposits and money market funds. These investments have one thing in common: they feel safe and are easily accessible, and you see your money daily on the screen.

In South Africa cash investments are as popular as biltong and braais. Before the ABSA Money Market Fund was closed, it was the biggest unit trust in the country – which shows how comfortable people are with the idea of ‘visible’ money. Many people also say: ‘I can see my money is there, after all.’ And that gives them a sense of control.

But that feeling of security is often misplaced.

Inflation and taxes: the silent guzzlers

The first big problem with cash is inflation. Let us say you get 3% interest on a savings account, but inflation is 5%. After a year, your R100 000 has grown to R103 000 – but in reality, you require R105 000 to be able to buy the same things. Your balance has grown, but your purchasing power has declined. It is like pouring water into a bucket with a hole in it – you see it becoming fuller, but it does not help later when you are thirsty.

Then there are taxes. If you hold R1 million in cash and earn 6% interest (R60 000), only R23 800 of that is tax free. The rest is taxed at your marginal tax rate. Take that as 36%, then you pay more than R13 000 to SARS. Your real return after tax is then only about 4,7%, and if inflation is higher, you are still losing purchasing power.

Fixed deposits – not without risk

Now, you might say: ‘But fixed deposits do pay better interest!’ That is true, but there are pitfalls. I was in Johannesburg and Pretoria recently to visit clients and when I reached Lanseria again, I saw a large billboard of a well-known sports star boasting about the good interest on his fixed deposit. The advertised rate was high – but many investors do not realise that this is often a simple interest rate, not a compound one.

If you invest R1 million at 10% simple interest, you receive R100 000 per year – in other words, R500 000 after five years. But if it had been compound interest, your returns would have been closer to R620 000. The actual effective compound rate in the first case is therefore just about 8,5%. That is a big difference lying in the fine print.

Another risk is liquidity: fixed deposits lock up your money. If you need access before the term expires, you may have to pay heavy penalties – which further erode the returns. And if you are a young person who could have placed that money in an equity fund, the opportunity costs are even higher.

The importance of growth – particularly for young and retiring investors

I always say: cash is a parking bay, not a destination. It has a place in a portfolio – for short-term needs like an emergency fund or deposit on a house. Even for retired clients we always keep one year’s income in cash.

But if you are saving for retirement or are working with an investment horizon of five years and longer, you must focus on growing your portfolio. The equity market has historically provided an average return of inflation plus 5 to 6% per year. In contrast, cash usually offers only a return equal to inflation. That is a huge difference.

Let us look at a straightforward example:

R1 million invested over 20 years at 6% grows to approximately R3,2 million. But that same R1 million in a growth-focused investment portfolio at 11% grows to R8,2 million. That is literally two different retirements.

Yes, shares involve volatility. But over time those ups and downs level out. Like Warren Buffett says: ‘It is about time in the market, not timing the market.’ And that is precisely the asset that young people have, and that cash cannot utilise for you.