Is cash king during an economic downturn?

The historically low interest rates we’ve seen over the past 10 years have been a boon for those with mortgages but for savers, it’s meant minimal returns on their investment. The tables are beginning to turn, with interest rates once more rising and speculation that we could be heading for an economic downturn or even recession.  

So, what does this mean for savers?  

The definition of a recession depends a lot on who you ask, however the most accepted one among economists is a sustained period of weak or negative Gross Domestic Product (GDP) growth paired with a big rise in the unemployment rate.  

Other indicators of economic activity are also weak during a recession such as reduced household spending, low business investment, and higher rates of unpaid loans due to businesses defaulting. 

Recessions are typically triggered by an ‘overheated’ economy when demand for goods surpasses supply, often accompanied by low unemployment. This usually results in interest rates rising (as we are now seeing) to put the brakes on spending.  

As it costs more to get or have a loan, many consumers and businesses will either not take out a loan or reduce spending in other areas to allow for the higher repayments, which causes the economic growth and subsequently inflation to slow down.  

If this period of slow or negative growth continues for an extended period of time and is accompanied by a rise in unemployment, the economy has entered a recession. 

The Reserve Bank of Australia (RBA) has been raising interest rates over the last few months to help control spiralling inflation by putting the brakes on household and business spending.  

Spiralling inflation could have disastrous consequences for the Australian economy as it erodes purchasing power and disproportionately affects those with less money. It also feeds on itself, with workers demanding higher wages and employers in turn passing those costs on by raising prices.  

Several additional interest rate rises are anticipated over the coming months to help slow the rapid rate of inflation. While many financial experts are saying this will peak in December, it depends entirely on whether or not inflation is brought back to the RBA’s 2% to 3% target.  

While the rising interest rates are concerning to mortgage holders, those with large amounts of cash in savings accounts stand to benefit from the increases after a long period of low interest rates.  

Many savers are now seeing greater returns on their cash than they have over recent years, as the interest rates rise. 

Yes and no. Cash is one of the lowest risk investment options available. You can access your funds more easily than other investment types and the risk of losing your money is far lower than other asset classes like stocks and property, which can be more volatile.  

Cash typically provides lower returns over the long term when compared to stocks and property, but is more stable, which is why many financial advisers will recommend shifting your superannuation risk profile from high growth (higher proportion of assets like stocks and property) to conservative (higher proportion of assets like bonds and cash) as you reach retirement age.  

Because cash is considered such a low-risk investment option, financial advisers often recommend including it as part of a diversified investment portfolio alongside growth assets (like stocks and property) to help shield your wealth from the impacts of market fluctuation. That way, if one of your assets takes a hit from the market (as we’re seeing now with stocks and property), then you haven’t lost everything.   

This is particularly true during a period of economic downturn, when many growth assets provide limited or negative returns.  

Another reason cash is such as safe investment option is because it is protected by the Federal Government’s Financial Claims Scheme (FCS). This scheme protects deposit-holders with Australian incorporated banks, building societies and credit unions, and general insurance policyholders and claimants (also known authorised deposit-taking institution or ADI) as in the unlikely event their financial institution fails.  

The FCS provides a government-backed safety net for deposits up to $250,000 per account holder per ADI. It also covers most general insurance policies for claims up to $5,000 (potentially more, if set criteria is met).  

This scheme was established following the 2008 Global Financial Crisis to help protect consumers if anything like that should happen again. 

Recessions have historically only last around 11 months on average in Australia, so unless you need money immediately, it’s best to stay the course with your current investment strategy, or you could risk cementing your losses.  

If you receive any lump sum payments during a recession (such as an inheritance, redundancy, or proceeds leftover from downsizing), it may be a good idea to keep this money in a high interest savings account while you discuss your options with a financial advisor. What you do with this money will depend entirely on your goals and appetite for risk.  

If you have a lower appetite for risk or may need the cash in the next 5 years (such as if you’re planning to renovate or buy a new car), a high-interest savings account or term deposit could be the right choice.  

As always, before you go making any big financial decisions, it is strongly recommended to speak with a financial advisor to get tailored advice based on your personal circumstances, goals, and risk profile.  

For further reading: RBA Source 1, RBA Source 2 , AFCA