In July last year, I wrote an article titled “Is Cash Really King?”. Following increases in interest rates and volatility in investment markets, more investors were being tempted by the higher returns offered by cash. My article focused on the potential impacts of holding too much cash or jumping from investments to cash, where the value is often silently eroded by inflation over time.
Last year, interest rates available on instant access cash peaked at around 5%; however, they started the year at around 2%, so the actual returns generated were much lower than the headline rates. For example, looking at the total return on some of the highest interest-bearing and most popular instant access cash accounts, the returns for 2023 were between 3 and 3.5%.
In comparison, the inflation rate (measured by the Consumer Prices Index) in the UK for 2023 was 4%, so cash had a negative real return of 0.5 to 1%. For capital which has a shorter time horizon (one to two years), this is not a significant problem and an acceptable price to pay to benefit from the increased optionality and liquidity that cash offers.
However, an issue arises when this impact is compounded over a longer period and with significant portions of capital that do not need to be drawn upon for some time. In this scenario, stock and bond investments are your best chance of outpacing inflation and growing your real wealth despite the volatility that comes with them. There is a false security that comes with holding cash.
2023 provided a perfect example of this. By July last year, the returns on our balanced investment strategy (TM2) were roughly the same as what you would have gained from holding cash, though you would have experienced far more ups and downs with the former. It is unsurprising, therefore, that investors were tempted to shift investments to cash to attain greater perceived safety. However, fast-forward and our balanced investment strategy ended up returning 8% by the end of the year, over double the return on cash.
As I have written previously, the seduction of safety is always more dangerous than the illusion of uncertainty. Whilst cash provides short-term stability, optionality, and liquidity, it would be unwise for it to form a significant portion of any long-term investor’s portfolio who is looking to grow their real wealth.
By Jonty Brooks
General Disclosures: This article is based on current public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.
