Holding cash for short term goals is important; people need cash for daily living, but over the long-term consideration should be given as to whether it is the right asset class
There is something comforting about cash; we know if we have £100 in the bank and we don’t spend it, we will still have £100. Whereas, if we put £100 into the stock market we must accept that it could go down as well as up; although a loss is only a loss if we “cash” the investment in, it stills feels uncomfortable when we see money go down in value.
Of course, there are good reasons to hold cash; short term plans like a deposit for a house, home repairs, a holiday etc. But, it seems some hold cash for periods of five years plus and in doing so it becomes a more “risky” investment. In this blog, I want to cover the different areas that affect cash when held long term.
Low Interest Rates
Savings rates have been in decline since 1998; when the average savings rate was 6.33%. They dropped to 3.68% in 2002 before rising to 5.55% in 2007. Since then they have fallen to an average of 1.23% (source: swanlowpark.co.uk).
Interest rates will go up but we don’t know when. When they do, it is likely to be slow and at a much lower rate than that seen in the past.
Effects of inflation
Inflation is now greater than the average savings rate. This means the real value of savings (after inflation) is falling. The table below from Standard Life Investments shows how inflation could impact a £10,000 pot. The balance may still say £10,000, but ‘purchasing power’ reduces as prices increase.
| Estimated interest rate | 1.00% | 0.95% | 0.90% | 0.85% |
| Estimated inflation | 2.50% | 2.50% | 2.50% | 2.50% |
| Years | 5 | 5 | 5 | 5 |
| Estimated real value (after inflation) | £9,289 | £9,266 | £9,244 | £9,221 |
Inertia
A recent report from the FCA (Financial Conduct Authority) showed just 10% of people they surveyed actively monitored rates on their cash accounts. The reasons for not doing anything varied from ‘keeping accounts in one place’, ‘they were happy for other unspecified reasons’ or simply they felt ‘they didn’t have enough money to monitor rates’.
If the FCA report is correct, that means 90% of cash investors will likely miss out on the most competitive rates.
Inefficient use of tax allowance
Recent changes to the Personal Savings Allowance means that up to £1,000 of income from savings (basic rate taxpayers) and £500 (higher rate) will be tax-free. This means in many cases there is no real difference between a cash ISA and an instant access savings account, and yet most people assume an ISA is the best choice. Holding cash in an ISA uses up the annual allowance which could be directed to a stocks and shares ISA.
History
Scottish Widows produced a UK Financial History Chart (1950 – 2016).
£100 invested in the UK Building Society Index in 1950 would be worth £5,559 today (this is with interest re-invested). This is slightly above the Retail Prices Index which would be £3,134.
The same amount invested in the Barclays Equity Index (Dividends Reinvested) would be worth £182,494.
Effectively, history shows that holding equities in the long term is more beneficial than holding cash. There is a risk that equity values can go down; Fidelity have shown over 12 months there is 25% chance of “losing” money, but over 5 years this drops to 16% and over 12 years zero.
Conclusion
Holding cash for short term goals is important; people need cash for daily living, but over the long-term consideration should be given as to whether it is the right asset class. It is not risk free with inflation and low interest rates all having an impact on potential “returns”.
Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.