A consistently high cash allocation may prove detrimental to investors’ retirement, according to the 2016 Legg Mason Global Investment Survey.
The survey of 500 affluent U.S. investors conducted from December to January found that the average asset allocation to cash in 2016 is 23 percent. This is a slight increase from the 2015 and 2014 surveys, in which 22 percent was the average cash allocation.
(Legg Mason defines an affluent investor as someone with a minimum of $200,000 in investable assets not including their home.)
“Certainly, having a 23 percent allocation to cash is almost the one strategy that guarantees you won’t achieve your objectives,” Tom Hoops, executive vice president at Legg Mason, told our sister site, ThinkAdvisor.
Hoops pointed out that in the same survey investors reported that they expected a 7 percent average annual portfolio rate of return.
“This group has told us that they expect their portfolios to generate around 7 percent return every year,” he said. “But yet with a 23 percent allocation to cash, the math on how one gets to a path of 7 percent is very difficult. It would really require a 14 percent to 15 percent return on their equity portfolio each and every year. And while that’s certainly possible on any given year, I think to count on that consistently year in and year out is difficult.”
If investors want to achieve this 7 percent rate-of-return objective, Hoops said “something has to be done” about their cash allocation.
“Moving away from [cash] into a set of investment outcomes and investment strategies and diversifying risk is, in almost every way, less risky than continuing with a very large cash position and a 7 percent portfolio objective,” he added.
First, one must ask why investors are consistently holding a significant portion of their assets in cash.
Hoops said many people often attribute this large cash allocation to investors’ fear.
“The consensus narrative is people are sitting on a lot of cash because they’re scared,” Hoops said. “They’re scarred from the great financial crisis, and so they’re hoarding this big cash position.”
Hoops thinks it’s something else rather than fear that’s keeping investors in cash: indecision. Investors are looking at two “difficult” choices, fixed income and equities, and as a result doing nothing, Hoops added.
“I think it’s less about fear, and more about the major issue facing older investors today. Which is, traditional fixed income doesn’t provide the income they need. And, they’re already fairly, fully invested in long-only equities and they don’t want to increase that volatility,” he said.
The average age of those surveyed was 60 years old, and, as Hoops said, this is a cohort that needs income. Facing increasing longevity, this is a cohort that also still needs some growth and some total return in their portfolio.
According to Legg Mason’s study, investors have around 41 percent, on average, allocated to equities.
“I would theorize that they probably are reluctant to double down on their volatility in the equity space because they’re already at 41 percent,” Hoops said.