Cash or Long-Term Investing?

It is perfectly understandable that investors see advantages in keeping more of their wealth in cash at present, but investing in the markets makes long-term sense.

With top-paying savings accounts in the UK now paying interest in excess of 4%, and rates available on one-year fixed term accounts even higher, many people are now wondering whether they should simply hold onto their cash savings rather than investing or indeed, move out of invested assets into cash.

There is wariness of the additional risk associated with maintaining or putting their savings to work in markets, particularly given the recent volatility across asset classes. As a result it does require a balanced response.

We maintain that there is a strong case for holding cash and it is important to maintain a cash buffer as part of an overall portfolio to meet short-term financial requirements such as income or to see people through unforeseen events such as redundancy.  It can also act as ballast to help shelter portfolios from volatility. Indeed, with returns on cash at current levels, fund managers see it is a much more appealing asset than it has been for several years and nor will it lose value in nominal terms. Furthermore, returns should increase as interest rates rise, although this will not be the case for any fixed-term accounts.

The latest hike by the Bank of England base rate of 0.25% to 5.25% (August 2023) indicates that we have not yet reached the end of the current tightening cycle, particularly if inflation continues to prove stubborn - something which the Monetary Policy Committees seems determined to address through further increases in interest rates. There is some indication that inflation is easing and should it fall below cash rates, investors will make gains in real, not just nominal terms. 

Clearly, the downside to cash is that returns will diminish as interest rates fall and providers tend to be very fast in cutting the rates as they drop.  The margin on interest rates is an attractive source of revenue for banks and building societies and they will seek to optimise this in their favour.

Yields on bonds are typically higher than those from cash. The UK 10-year government bond is currently yielding 4.36% and corporate bond markets even more than this - closer to 5.99% for the UK corporate bond market.  These yields will likely fall as interest rates drop thereby boosting bond prices and adding capital growth. For example, a 1% fall in yields should lead to a capital gain of around 10% for a 10-year bond. Cash, however, must be held on account or invested in a money market fund for the whole year to capture the full rate.

Furthermore, investors choosing to remain in cash will not participate in any sustained market recovery, and bonds and equities are both asset classes that have proved to deliver returns ahead of cash rates over the long term. Being out of equity or bond markets on days when they move up very sharply dramatically reduces the long-term returns for portfolios.  The effect of this is has been evident following the Global Financial Crisis in 2008 and more recently with the COVID Crisis in 2020.

As the saying goes, it is time in the market that matters, not timing the market, and consistently timing the market correctly is impossible. Days when markets trend strongly upwards often happen when markets are volatile and performing at their worst.  Investing when the market is at a low ebb also benefits longer term returns.

Source: Square Mile and FE fundinfo. Data as of 30 June 2023.

 For returns on cash to outpace inflation, the rate paid needs to be higher than the level of inflation. This peaked at 9.6% in October 2022 and now stands at 6.4% (July 2023) in the UK, and so cash does not currently offer returns in real terms. With signs that inflation is beginning to ease, the need for high interest rates to address it will diminish. Indeed, the Bank of England is treading a delicate line, since keeping interest rates at an elevated level risks prompting a recession and destabilising the housing market.  This means the likelihood of interest rate cuts, and therefore lower rates available on cash, increases.

It is also worth noting that some accounts only allow a limited amount to be invested each month, up to a maximum level for the year. Meaning in the first year you will not receive the cash rate on the full amount allowed and only on the amount that is invested each month. This will likely be reduced if rates fall. Worthy of note too is that Fixed Rate returns require your money to be locked away for a stated period of time, restricting access and therefore your liquidity.

 Whilst the perceived safe haven of cash into higher risk assets may appear challenging. With the seemingly constant stream of negative news at the moment, it is perfectly understandable that investors see advantages in keeping more of their wealth in cash.

However, notwithstanding the fact that holding some savings in cash makes sense for short-term goals, investing in the markets is far more likely to help you achieve long-term financial aspirations. As history demonstrates, markets will bounce back from periods of doom and gloom and can be the most effective way of making client savings grow in real terms, ahead of inflation.

At Prosperis we continue to maintain the philosophy of long term investment and that portfolio diversification is the best way to achieve your goals.  Please contact your Prosperis adviser on 01423 223640 or advice@prosperis.co.uk if you require any further information.

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