Stick or Twist = Cash versus Investing
Chris Broome – Chartered Financial Planner
In the midst of today’s financial landscape, the appeal of preserving wealth in cash is undeniable.
However, opting for market investments holds its own merit for long-term viability.
As high-yield savings accounts in the UK offer interest rates exceeding 4%, and one-year fixed-term accounts even promise greater returns, individuals are grappling with the decision of whether to retain their cash savings or venture into investment opportunities.
Discussions with financial advisors highlight the recurring query from clients, who remain cautious about assuming the additional risks associated with deploying their savings into markets, especially considering the recent market turbulence.
A well-rounded response is in order.
The argument for maintaining cash reserves is robust. A cash buffer is crucial within an overall portfolio to meet immediate financial needs or navigate unforeseen circumstances like job loss.
It also serves as a stabilizing force, shielding portfolios from volatility.
Given the current cash returns, it emerges as a more attractive asset than it has been in years, with the added benefit of retaining its nominal value.
Moreover, as interest rates rise, returns are expected to climb, although this might not be the case for fixed-term accounts.
The recent 25bps elevation of the Bank of England base rate to 5.25% suggests that the current phase of tightening is not yet concluded. This holds particularly true if inflation persists—a concern the Monetary Policy Committee is determined to address through further rate hikes.
While signs of easing inflation are evident, a scenario where inflation dips below cash rates could lead to real gains for investors.
However, the flip side to cash investments is the diminishing returns as interest rates decline. Providers are swift to reduce rates in response.
In contrast, bond yields tend to surpass those of cash. The UK’s 10-year government bond, for instance, presently yields 4.36%, with corporate bonds offering even higher returns—hovering around 5.99% in the UK corporate bond market.
As interest rates drop, bond yields are likely to follow, enhancing bond prices and contributing to capital growth. For instance, a 1% yield drop could translate to roughly 10% capital gain for a 10-year bond.
Cash, on the other hand, necessitates a year-long commitment to realise the full rate, either held in an account or invested in a money market fund.
Moreover, choosing to stick with cash denies participation in sustained market recoveries.
Both bonds and equities have demonstrated their ability to outperform cash rates over the long term.
Investing into the Great Companies of the World
The adage “time in the market matters more than timing the market” holds true, as trying to predict market trends accurately is a futile endeavour.
Often, the most significant market upswings occur during periods of heightened volatility and poor performance.
For cash returns to outpace inflation, the interest rate offered must exceed the inflation rate. In the UK, this stands at 7.9%, indicating that cash presently falls short in real returns. With hints of inflation’s decline, the urgency for high-interest rates to combat it diminishes.
The Bank of England finds itself delicately positioned, as maintaining elevated interest rates risks economic downturn and destabilizing the housing market. This raises the probability of rate reductions and subsequently lower cash rates.
It’s worth noting that certain accounts impose limits on monthly investments, often with a maximum annual threshold. This implies that in the first year, the full cash rate is applicable only to the invested monthly amount, a figure that could decrease should rates drop.
Encouraging clients to shift from the perceived safety of cash to higher-risk investments can indeed pose challenges. In the face of continuous negative news cycles, it’s entirely understandable that investors find solace in preserving more of their wealth in cash.
However, beyond the merits of safeguarding short-term goals, delving into market investments is considerably more likely to pave the way for clients to realise their long-term financial ambitions.
Historical patterns illustrate the resilience of markets, even in the face of pessimistic periods.
Such investments offer a pragmatic route to ensuring that client savings flourish in real terms, outpacing the effects of inflation.
With savings rates at a recent all time high, it’s understandable to be considering deploying your hard-earned capital into that asset class.
The challenge you face is that (a) the rates offered are still below inflation, meaning your purchasing power is still being eroded in real terms, and (b) by selling out of your equity position you’re highly likely to miss out of the returns surely to follow when the markets recover and start growing again – as the historic data has shown always happens.
The truth is that, over a 30+ year retirement, your money will do one of only two things:
(1) It will either run out before you die.
(2) Or it will outlive you.
At Longhurst we build financial plans for our clients that focus on point (2).
We do this with careful and research-backed consideration towards which asset classes are to be used, how, and when.
Get in touch if you’d like to learn more.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investment can go down as well as up and you may not get back the full amount you invested.
Past performance is not a reliable indicator of future performance.