Investing in the stock market and sitting on cash might seem like mutually exclusive options, however cash instruments play a key role in the successful diversification of portfolios, says Himal Parbhoo, the CEO of FNB Cash Investments.
Global markets have experienced significant volatility due to the Ukrainian war, increased inflation and the Covid-19 pandemic, resulting in the recent equity sell off.
“In times of market volatility and increased risk, cash instruments should be considered by investors as a diversification and risk mitigation tool,” Parbhoo said.
How does a cash element benefit an investor’s portfolio?
Adding a cash element to a portfolio allows an investor to decrease portfolio risk and secure an additional income stream in the form of regular interest payments.
The use of different cash instruments can also shelter portfolios in the case of large market moves and ensures an element of income is forever present in adverse equity environments.
In a bull market, cash performance will be significantly lower than that of the stock market but having a cash element in a long-term portfolio ensures that yield is achieved regardless of how the market performs.
Cash as an offensive asset
Parbhoo said: “Cash can be a powerful offensive tool in securing interest income, whilst offering the opportunity to capitalise on equity buying opportunities should the pull-back result in good entry positions regarding value“.
A cash element within a portfolio means securing an additional income stream as well as having a war chest should equity prices pull back into value opportunities.
What are the different types of cash instruments investors can use?
Money market account
Offered by most traditional banks, a money market account has similar characteristics to a traditional savings account, however, it typically gives investors with a higher interest return.
Customers need to deposit minimum amounts and then maintain that minimum balance. The interest rates offered are variable and linked to the repo rate.
Money market fund
A money market fund invests in highly liquid near-term money market securities such as cash, cash equivalent securities and bonds with a maturity of less than 13 months. Although not as safe as the money market account, this fund is viewed as a low-risk asset because it provides higher returns than a standard savings account.
Linked to the repo rate, this savings account requires an investor to give notice before taking funds out of the account. The longer the notice period, the higher the interest returns offered by the financial institution.
A fixed deposit allows investors to fix the interest received over a fixed period. The longer the period fixed, the higher the returns offered. Changes to the repo rate will not impact this cash instrument.
A fixed deposit allows investors to receive reliable and consistent cash flow in the form of fixed interest returns.