Cash or stocks, which is higher risk?

Having cash is necessary for short-term liquidity, but keeping it for the long term erodes its value. (Pixabay pic)

Is cash a low-risk investment? Are stocks high risk? What is the difference?

This article explores this topic in depth and offers a fresh perspective on what is of greater risk.

It includes a useful tip to strike a balance between saving and investing money so everyone can build wealth sustainably and confidently.

Is cash lower risk than stocks?

At a glance, it would seem that holding cash is a lot safer than investing in stocks. This belief stems from looking at assets (cash and stocks) based on their dollar value and how that amount fluctuates over time.

For example, putting RM100,000 into a savings account, assures that one can retrieve RM100,000 from the account six to 12 months later.

But, invest RM100,000 in a stock portfolio and the very next minute, the value of the portfolio can change. Six to 12 months later, the dollar value could be lower, higher or equal to RM100,000. In short, there is no certainty of getting back that RM100,000.

Therefore, because of the fluctuation in the dollar amount, cash is viewed to be safer than stocks. This has caused many to put their money into fixed deposits instead of investing it.

But the belief that cash is a lower risk investment than stocks is not completely true. It can be true only if it is viewed in the short term.

Here is why holding onto cash for the long term is risky and why it is possible for stocks to be a lower risk investment than cash.

Can stocks be of lower risk than cash?

Take a 10-year perspective. A saver puts RM100,000 into a savings account 10 years back. Today, they can retrieve a little more than RM100,000 due to the interest.

Hence, the dollar amount is almost the same as 10 years ago. But, what can they buy with it? The value of that RM100,000 today would be a lot less than its value 10 years ago.

Simply put, cash hoarding is guaranteed to erode wealth in the long term as cash depreciates in purchasing power over time. Today, the speed at which it loses value is faster than ever before with cuts in the Overnight Policy Rate.

This means the cost of money is cheaper, savers are getting less for their savings and borrowers who know how to use debt to get richer will emerge victorious. Debt is now cash.

The situation is different when investing in stocks. Investing here refers to buying, holding and accumulating good stocks for the long term. It is not stock trading, which is very different.

A good stock is one that has a track record of growing assets, sales, profit, cash flow and dividend payouts for the long term (10 years).

For example, an investor may have purchased RM100,000 worth of Public Bank Bhd shares 10 years ago.

Over time, the bank expands its customer base, loan portfolio, product range, assets, profit and dividend payments.

Today, the investor would have collected RM48,000 in dividends from Public Bank and their investment in the bank would have grown to RM153,000 in market value. Hence, in essence, he doubled his wealth in 10 years.

In the long-term, it is better to convert cash into income-producing assets where their market value will be revised upwards as they earn more income for their owners over time as opposed to holding cash.

Buying, holding and accumulating good stocks increases the value of the investment over time. (Pixabay pic)

Conclusion: Striking a balance between saving and investing

In the short term, cash is lower risk than stocks as a store of wealth. But in the long term, cash is of higher risk than stocks as a store of wealth. Therefore, both are needed: Saving and investing.

Each has a different purpose. Saving is for a rainy day and it can come in handy in times of need.

It can be used to fund living expenses if business is slow, or if one has been retrenched or had a pay cut. It can be used to fund immediate needs such as a wedding, buying a new home or even to pursue a career switch or a new business venture.

Savings is about liquidity, not for wealth building.

Investing is about building wealth in the long term. It is a necessary skill to learn and master for cash is perishable in terms of its purchasing power and is a poor store of wealth for the long term.

This article first appeared in kclau.com

Ian Tai is the founder of Bursaking.com.my, a platform that empowers retail investors to build wealth through ownership of fundamentally solid stocks. It is an essential tool that sifts out stocks that grow profits consistently from a database of over 900+ stocks listed mainly in Malaysia.

from Free Malaysia Today https://ift.tt/3l9cu6r
via IFTTT