Put cash to work

Cash is often referred to as a risk-free asset and a store of value. But it has a poor track record of holding value over the long term. With nominal interest rates currently lower than inflation, real rates are negative, increasing the drag from cash. Once investors have sufficient liquidity to meet up to five years of spending needs in excess of income, we recommend focusing on long-term returns by seeking yield and growth.

Markets are pricing the ECB deposit rate to trade below zero for years, with Swiss policy rates expected to be even lower than ECB rates. Assuming any inflation, real rates will remain even lower. What’s more, negative central bank interest rates are filtering through the financial system, and it looks probable that more banks will pass on the cost to depositors. All this means that the purchasing power of cash will be eroded over time, as the cost of goods and services rise faster than the income earned on cash holdings.

We believe investors need to re-think the role of cash in their portfolios. Around 62% of investors surveyed in our Investor Sentiment survey hold more than 10% in cash and equivalents. Cash will continue to be of use to meet immediate expenses. But for investments earmarked to meet longer-term spending needs, the short-term safe-haven qualities of cash become a liability because they reduce potential investment returns.

So, while cash holdings are necessary, excessive cash creates a drag on returns. We believe investors should consider their liquidity in three main tiers: Tier I is for everyday cash needs in the coming 6-12 months; Tier II is savings cash for known needs over the coming two years; and Tier III is investment cash to meet potential investment opportunities over the coming 2-5 years. The first two tiers in our view should be mostly held in cash deposits, and investors who can consider taking on more credit, market, or counterparty risk have the potential to earn higher returns in Tier III, for instance by investing in a well-diversified bond portfolio or yield-focused structured solutions with terms that include principal protection. One such strategy for investors looking to generate a return pick-up versus short-term bonds while maintaining capital preservation is to consider market-linked certificates of deposit (MLCDs). We estimate that 5-year MLCDs could offer around twice the expected return of 5-year Treasuries, in return for investors locking up their capital and accepting some return uncertainty.

Investors should also consider setting aside borrowing capacity—for example, a securities-backed credit line—to fund a portion of their Liquidity strategy. This can reduce the potential drag on returns that comes from holding cash and high-quality bonds.

Beyond this, we recommend investors put their cash to work beyond their Liquidity strategy and into funding their Longevity and Legacy strategies, in strategies that are geared for greater long-term growth potential such as balanced portfolios or equity markets. 

Investing in structured investments involves significant risks. For a detailed discussion of the risks involved in investing in any particular structured investment, you must read the relevant offering materials for that investment. Structured investments are unsecured obligations of a particular issuer with returns linked to the performance of an underlying asset. Depending on the terms of the investment, investors could lose all or a substantial portion of their investment based on the performance of the underlying asset. Investors could also lose their entire investment if the issuer becomes insolvent. UBS Financial Services Inc. does not guarantee in any way the obligations or the financial condition of any issuer or the accuracy of any financial information provided by any issuer. Structured investments are not traditional investments and investing in a structured investment is not equivalent to investing directly in the underlying asset. Structured investments may have limited or no liquidity, and investors should be prepared to hold their investment to maturity. The return of structured investments may be limited by a maximum gain, participation rate or other feature. Structured investments may include call features and, if a structured investment is called early, investors would not earn any further return and may not be able to reinvest in similar investments with similar terms. Structured investments include costs and fees which are generally embedded in the price of the investment. The tax treatment of a structured investment may be complex and may differ from a direct investment in the underlying asset. UBS Financial Services Inc. and its employees do not provide tax advice. Investors should consult their own tax advisor about their own tax situation before investing in any securities.