How much cash should retirees hold?

In recent months, the RBA has reduced the cash rate to an unprecedented historical low of .75 per cent. This reduction affects many ordinary Australians. The RBA cash rate influences the banks’ cost of funds. Therefore, the cash rate has an impact on the rates that the banks charge for mortgage loans. The cash rate also affects the interest that banks are prepared to pay depositors. So, both mortgage interest rates and the interest credited to “at call” accounts have fallen markedly. These changes raise the issue of the proportion of retirees’ financial assets that they hold as cash –  their ‘cash investment allocation’.

Deeming rates
At the same time, there has been a furore over the ‘deeming rates’ used by the Australian government for the purposes of the Age Pension income test. For the purposes of the income test, the government uses ‘deemed’ income from financial assets rather than the actual income. The ‘deemed’ rates are one per cent for the first $51,800 of financial assets (for a single pensioner) and three per cent for additional financial assets. The threshold for a couple is $86,200. Seniors groups are not happy, correctly pointing out that retirees can no longer earn three per cent on their money if they invest in ‘at call’  bank accounts or term deposits.

But the point of this article is not so much to argue the rights and wrongs of the deeming rates. Rather, I query why so many retirees want to hold a very high cash investment allocation.

Cash as an asset class
We all know that cash is the asset class that yields the lowest investment return. Any other investment (bonds, hybrids, shares, property) is likely to produce better returns than cash in the long run. Yet the fuss over deeming rates suggests that many retirees do have significant cash deposits. And I have been surprised to find, in recent discussions with half a dozen acquaintances, friends and relatives, that even some well-informed investors are holding large allocations to cash.

Valid reasons to hold cash
Let me say before proceeding that there are good reasons why you may want to hold cash. First, many financial advisers recommend (and I agree) that it is appropriate to hold some cash as an ‘emergency fund’.

The amount in your emergency fund might be between three months’ and one year’s worth of living expenses. The idea is that you have immediate access to your emergency fund if something goes wrong. For example, you may lose your job or incur a major unexpected expense. It makes sense to hold your emergency fund in cash where you have immediate access to it without any risk of decline in value. A great place for your emergency fund is in your mortgage offset account, if you have a mortgage.

Or maybe you are 88 and in failing health. You want to ensure that your care needs can be met professionally in an aged care facility of your choice. You are concerned that you will soon need to find a Refundable Accommodation Deposit (RAD). It would be reasonable to hold cash or short-term deposits up to the amount of the anticipated RAD.

But what about retirement savings?
What I’m really talking about is people who are holding large amounts of cash to fund their retirement income needs, without any short-term need for large amounts of liquidity. In this situation, it’s hard to see a strong rationale for holding much more than five to 10 per cent of your financial assets in cash. So why do people do it?

Not-so-valid reasons for holding a lot of cash
I suspect that there are many not-so-good reasons for a high cash investment allocation. Such reasons include laziness, procrastination, lack of financial literacy and excessive anxiety about the potential for market values to fall. People remember that Australian shares fell by more than 50 per cent during the GFC and think to themselves, “I can’t afford to lose half my wealth”.

But this fearful approach ignores some very important points. First, you can invest in a wide variety of ‘growth assets’, it doesn’t have to be Australian shares alone. A typical Australian superannuation fund invests in infrastructure, overseas equities, property and fixed interest securities as well as Australian shares. And when some parts of a diversified portfolio perform poorly, other components will do well. For example, government bonds will tend to do well when shares are performing poorly. Usually when ‘boom’ turns to ‘bust’ in share markets, interest rates fall, causing bond prices to rise.

What if the market falls?
Even if the market value of your investments falls significantly, that doesn’t necessarily have implications for your long-term future spending ability. After every market correction comes a recovery, sometimes very quickly. As long as you don’t need to spend much more than the investment income, it doesn’t matter much what market values do in the meantime.

Retiree investment timeframes
Even a retiree like me (I’m 63) has a potential investment timeframe of three decades. What happens to market values today, or this week, or this month, or next year, is almost irrelevant to the future flow of investment income from my portfolio for the next three decades.

Super fund performance
As a demonstration of how a diversified, growth-oriented fund can perform, I reviewed the long-term performance of the nation’s largest superannuation fund, AustralianSuper, over the last 33 years. Their ‘balanced’ investment option had a negative return in only three of those 33 years! And two of those negative returns were single digit (less than 10 per cent). True, investors in the Aussie Super Balanced fund experienced an investment return of negative 13.3 per cent in the 12 months to June 2009, in the midst of the GFC. But that was more than compensated for in the few years preceding the GFC and the few years after. Over the long term, Aussie Super (and some other well-performing super funds) have achieved between nine per cent and 10 per cent per annum average returns. You can’t get that by holding cash!

When you’re investing for a long period, you will almost certainly be better off in a diversified fund with a 60-80 per cent exposure to growth assets than you will be if you have a very high cash investment allocation. Earning nine per cent per annum over a long investment timeframe will produce a much better lifestyle than earning two per cent! Strategy 45 of my book Slow and Steady: 100 wealth-building strategies for all ages shows a simple way for investors with quite different risk profiles to invest and achieve much better rates of return than cash.

This article first appeared on

Do you try to hold an emergency fund in the bank even though interest rates are very low?

* John De Ravin is a retired actuary whose career included work in the Australian government actuary’s office and in insurance. He has degrees in science and economics and a graduate diploma in financial planning from Finsia. He is a Fellow of the Actuaries Institute, a Fellow of Finsia and a CPA. He is the author of Slow and Steady: 100 wealth building strategies for all ages.

If you enjoy our content, don’t keep it to yourself. Share our free eNews with your friends and encourage them to sign up.

Related articles:
Australian retirees versus the world
Govt looking after top end: report
Set to retire? Think again

Written by John De Ravin


How does Australia's retirement system stack up?

The OECD has released a report comparing retirement systems and Australia isn't performing as

Retirement review reveals how much the wealthy benefit from government support

Report sure to spark debate over the intended purpose of superannuation and tax breaks that favour

If you’re preparing to retire, you might need to think again

Older Australians must work for longer for a sustainable economy, says the Treasurer.