Cameron Watson, 21 March 2018

It is always interesting to look at history. As George Santayana famously said, “those who cannot remember the past are condemned to repeat it”.


We have been looking at historical interest rates recently, available off our Bloomberg, and using the excellent historical time series of interest rates available on the Reserve Bank of New Zealand (RBNZ) website.

In a balanced portfolio, cash sits alongside bonds as part of the more defensive ‘income assets’ bucket. A typical balanced portfolio might consist of cash and bonds, along with an allocation to riskier ‘growth assets’, such as shares and property, which have the potential to provide higher longer-term returns.

Here are our five takeaways from the historical data on cash.

1. Interest rates have been up and down

Reserve Bank data on deposit rates goes back to 1965, as shown in the chart below. What a ride it has been. In the 1960s and early 1970s, deposit rates were at a similar level as they are today. They hovered around 3% to 5%.

This cosy existence was shattered by the oil crises of the 1970s and the inflation that followed which sent interest rates soaring. Deposit rates hit 10% in the mid-1970s and rose further in 1980s. In the mid-1980s investors could earn 18% on deposits. Those who remember having mortgages during this time endured the flipside of these high deposit rates.

In New Zealand, the 1990s started badly. Our economy was mired in a grim recession, which saw interest rates decline to under 6%.

Rise and fall of NZ six month deposit rate

Source: RBNZ data

For those with term deposits, the 18 years from 1990 to 2008 was arguably a period of relative calm. Deposit rates still moved around – for example, they fell sharply during the 1998 Asian crisis – but overall, rates moved up and down within a range of 4% to 9%.

All that changed in April 2008.

2. Don’t bank on interest rates

In early 2008 the global financial crisis (GFC) took hold. Markets fractured, and central banks and governments rushed to put in place emergency measures to limit the economic damage. Part of this response saw central banks slash interest rates. In New Zealand, the six-month deposit rate was 8.4% in April 2008. By February 2009, it was 3.8%. Interest rates had more than halved in 10 months.

This had a devastating impact on those retirees who had put all their savings into deposits and intended to live off the interest. This was no longer possible – their income had fallen by 50%.

In a more ‘normal’ environment, such as we saw from 1990 to 2008, it would have been fair to assume interest rates would eventually rebound. Unfortunately, our current economic backdrop is anything but ‘normal’ and since 2009 interest rates have fallen further, not increased.

3. Cash for certainty, not returns

There are times when cash rates look attractive relative to shares. This is usually when interest rates are high,
as in April 2008 when deposit rates were 8.4%, or after a period of negative returns from shares, such as 2010.
At times like this we often see the expression ‘cash is king’ bandied about in the media.

However, these periods do not tend to last long; cash’s reign as monarch of the investment kingdom is often short-lived. Over the long haul, shares and property have historically provided higher returns than cash, as shown in the chart below.

Relative return from NZD

Note: The NZSX All Gross Index is a gross index and from 1 October 2005 assumes the reinvestment of cash dividends. Prior to this date, the NZX gross indices assumed the reinvestment of gross dividends (ie including imputation credits). The Australian All Ords Index is an accumulation (or gross) index and assumes the reinvestment of cash dividends. The MSCI World Gross Index is a gross index and assumes the reinvestment of cash dividends (ie it does not include tax credits). The NZ house price return shown above does not include any income that may have been derived from owning such property. It is purely a measure of capital return. The Wholesale Interest Rates return is after tax (now 30%).

Cash as an investment is like avocado, it is better when combined with something else. It should be part of a portfolio, but not the whole portfolio.

The key attraction of cash is certainty. Short-term goals need certainty, and cash (with bonds) can provide this. For example, a retiree may allocate a part of their portfolio to cash and bonds to fund the first 10 years of their retirement.

The longer term, perhaps from year 11, can then be funded with growth assets like shares as they offer higher returns and better inflation protection than cash. Speaking of inflation…

4. Inflation is the enemy of cash

Inflation is the nemesis of cash. The Reserve Bank calls it ‘the thief in your wallet’.

Deposit rates in New Zealand have, at times, struggled to keep ahead of inflation, and indeed lost the battle hands-down in the 1970s. See chart below.

Chart 3

Source: RBNZ data

The numbers in this chart make no allowance for tax, which would obviously further reduce the return on cash. Even today, with inflation being historically low, it still has a material impact. Taking the current six-month deposit rate of 3.25%, deducting tax of 21% leaves an after-tax return of 2.5%. Subtracting inflation (currently 1.6%) leaves a real after-tax return of just 0.9%.

5. Where to next?

Irrespective of where interest rates sit currently, or where they might go, cash still has a place in a diversified portfolio. It is anybody’s guess on where interest rates will be in a year’s time, or in five years.
At present, deposit rates seem to be behaving as they did in the late 1960s and early 1970s. Pity the music isn’t anywhere near as good today as it was then.