By Tim Collyer, Chartered Financial Planner at Montgomery Charles
Cash is back, or so it seems – with interest rates as high as 5 or even 6% at a time when other asset classes are not doing quite so well.
As a result, many are investing their ISA allowance this year into a cash ISA, and on the face of it – why not? A ‘risk-free’ return of 5 or 6% with no charges compares well with a diversified investment portfolio – a portfolio that is likely to go up and down in value given the geopolitical and economic turmoil of current times.
But is cash really back? History has taught us it might not be that simple – and here’s why.
Interest earned on your money rarely makes up for inflation
There have been times in the past where interest rates have been as high as 10 or 11%. However, inflation is almost always higher than the cash returns on offer at any given time, meaning your savings are losing value (i.e. – you can buy less in the future with £100 than you can buy now). This is why cash is not truly risk free. There are not many guarantees in investing, but you can almost guarantee that by holding cash, you are losing its buying power over time. And with interest rates likely to go down from here, inflation is likely to remain the enemy of cash.
It’s worth bearing in mind that the raft of new cash ISAs can give you flexibility. If interest rates do decrease, they can be simply transferred to a stocks and shares ISA, maintaining their tax-exempt status and retaining some protection against inflation, albeit at the expense of volatility.
History tells us that cash isn’t usually a serious investment asset
The Barclays Equity Gilt Study is an annual publication that examines the returns on a range of assets over the longer term. The study has been published every year since 1956 and the data used goes back to 1899. The study examines trends in . The study often looks at other factors such as demographics, climate change, the development of technology, and the implications for economic growth and prices.
According the 2023 Study, real returns on UK equities have averaged around 4.5% over the past 50 years, compared with 2.4% from gilts and 0.7% from cash. The average inflation between over the same period was 3.7%. In this analysis cash has been losing 3% per year to inflation on average.
Of all the asset types, only equities have made actual gains above inflation – and it is largely this knowledge that guides financial advisers on portfolio construction.
You need a rainy day fund – but how wet will it get?
The principles of financial planning typically suggest that a client keeps six months to a year of their earnings in cash as an emergency fund, and up to 10% of their portfolio for those relying solely on their investments to live on. Typically a financial adviser will want to ensure you have the cash to hand to cover the three years’ worth of day-to-day and ad hoc costs. This is because over a short period of time, cash will retain most of its value when accounting for inflation (the last couple of years notwithstanding).
Money you need beyond three years will tend to be allocated to a diversified portfolio of stocks and shares for the simple reason that such a portfolio is likely to have increased in value over that timescale and stands a good chance of having beaten inflation.
Depending on market conditions, holding more cash than you need to cover the next three years will normally work against you in the long run. Investing money you need more than three years down the line gives you the best chance of your money (at least) maintaining its value against inflation, and quite possibly growing in real terms.
Times of crisis require cash, but are few and far between
Putting emergency funds and money to cover expenditure to one side, does cash have any other uses when it comes to financial planning? During the credit crunch of 2008, the value of invested assets (both fixed interest and equities) fell. This left many people with a situation that in order to create liquidity (cash to hand), they had to sell financial assets – such as property, cars etc – at a loss.
These situations don’t happen often, so how much weight should you give to this kind of planning? Put simply, this is where a financial adviser’s insight is crucial. It’s their job to anticipate choppy waters, and they will also ensure your portfolio is well-diversified enough to withstand a crisis. (At Montgomery Charles, we implement diversification at four different levels, which is pretty much unprecedented in our industry.)
From all this we know that you need a mix of cash and equities – but how do you get the balance right?
Overall, whilst cash certainly has its part to play in helping you to meet your needs, the Barclays Equity Gilt Study reminds us of the importance of diversification and the historical resilience of equities over time.
We’ve also seen that as investors, staying informed and adaptable to changing market conditions is key to optimising our portfolios for both safety and growth.
On top of this, as independent financial advisers, we know that:
- Everyone has a different tolerance of risk (which will influence where and how you invest)
- Everyone is on a different journey, with their own ambitions and dreams – there’s no one-size-fits-all approach
With all new clients, our starting point is a comprehensive financial plan which maps out the journey you and your family are on, from the present day until retirement and beyond. Remember, investing is not just about seizing immediate opportunities; it’s about ensuring long-term financial health and achieving your financial aspirations.
Montgomery Charles are here to help you embrace the complexity of today’s financial landscape and to make informed, strategic decisions that will pave the way for future prosperity.
If you’d like to know more, the first step is to have an exploratory chat with us. These are complimentary, no-strings conversations that will give you an idea of how we can help transform your future. You can book online below, or call us at 01225 777 999. If you’d like more information you can read more about your potential financial journey with us, find out what others had to say, or just get more background on what we do.
