Cash is king but it comes at a cost

24th February 2015 by Justin Urquhart Stewart

By Ben Kumar, investment manager, 7IM

Most interest rates around the world are at, or close to, all time lows. The extreme case is Switzerland, where the national bank has set a negative base rate of -0.75%; meaning that it charges to take cash deposits. The reasoning behind central banks setting low or negative interest rates is complex, but two broad aims are:

• to encourage people to spend rather than save

• to encourage foreign investors to stop buying, and hence strengthening, the domestic currency (this is Switzerland’s main reason at the moment).

With all of the monetary policy battles being fought at present, central bankers could well find themselves nodding understandingly to Yogi Berra’s famous quote – “In theory there is no difference between theory and practice. In practice there is.” It will be some years, or decades, though before we can really analyse the outcome of these central banking experiments.

More interesting at present is the curious situation this negative interest rate world creates. Government bond yields have been dragged lower and lower – in Germany at the moment, a 2 year government bond has a yield to maturity of -0.2%. If you were to invest €1 million in such a bond, with the intention of holding it to maturity, in two year’s time you would be the proud owner of €996,000. Just to reiterate, people are investing money in instruments that, in the best case scenario, guarantee a loss – and that’s before taking any inflation into account.Aberrations such as this create opportunities to think outside the box – or in this case, inside it…M&G Investments’ Bond Vigilantes blog points out that for the conservative investor, there is alternative option to buying a bond – you keep the cash in its purest form, paying only for storage.

Holding €1 million in cash creates some physical problems though. The Eurozone does issue a €500 note which seems ideal for the job of bulk cash hoarding – in fact, it is so perfect that for some time it was known by European crime agencies as a Bin Laden, because everybody knew it existed, but only criminals ever saw it. Keeping things above board, let’s settle for the more familiar €100 note, which is 8.2cm by 14.7cm, and 0.0113cm thick. Stacking ten thousand of these notes would form a tower 1.13m tall – too big a wad for even the deepest pocket. Where to store it then?

The classic option is to hide it under the mattress. Spreading that tower of cash out across a double bed would raise the height by 0.5cm, although the impact on comfort sleeping might be uncertain. There would be no expenses – and the cash is easily accessible. The downside is that the cash is also easily accessible to any thief who has done his due diligence on “uninventive hiding places”.

A more modern approach would be to rent a safety deposit box at a secure institution, and place your pile of cash there. Obviously, in normal circumstances, this would be a ludicrous idea – you’d earn no interest and pay for the privilege…which is exactly the situation in short term quality government bonds, discussed above. That similarity reduces the issue simply to one of cost. A security deposit box large enough to fit €1 million – a cuboid of roughly 33cm by 15cm by 30cm, four stacks of 2,500 banknotes – costs about €1600 for two years. That leaves you €998,400 at the end of the period; which is €2400 better than had you invested in the German government bond…

Now there is probably more risk that a safety deposit box will be broken into than that the German government will go bust. I would say that both are relatively negligible probabilities though, making the safety deposit box a relatively credible idea.

Of course, in reality the number of people who would regard €1 million in cash as an annoying “problem” is pretty small. Nevertheless the example serves to illustrate the headache of being a conservative investor in a low-interest rate environment. Investors who don’t want to buy bonds don’t necessarily have to buy riskier instruments – instead they may just start thinking about risk in a different manner. Suddenly the trade off might be between guaranteed negative returns or the chance of being burgled…

We could be about to see a whole new wave of innovation – this time of low risk, conservative alternatives, whether they be financial products or real world solutions.


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