The value of investing versus cash

All of us need to hold enough cash to cover a few months’ worth of living expenses in an emergency fund, just in case.

But, what should you do with the rest of your savings once you’ve got that emergency fund sitting safely in the highest interest rate, government backed savings account you can find?

There are lots of ways to store and grow your wealth. And each comes with different levels of risk and potential returns.

This article is not personal advice. If you're not sure if an investment, or course of action, is right for you, please speak to a financial adviser. Unlike the security of cash, all investments rise and fall in value, so you could get back less than you invest. Past performance is not a guide to the future.

What sort of returns do we want?

You should focus on real, inflation-adjusted, after tax returns on your savings.

Inflation is the rate at which the price of the things you want to buy rises. The Bank of England (BoE) currently targets 2% inflation each year. This means cash loses value over time. So to end up ahead, you need to get an interest rate above the rate of inflation.

Since January 1999, when the BoE data on effective interest rates started, savers in easy access accounts have failed to keep up with inflation. This means they’ve lost money in real terms and their spending power has fallen.

Fixed-term savings accounts, where you lock your money away for a set period of time, have done better. Over this time (to 30 June 2020), £100 has grown to £194, or £128 after inflation.

This is the average of all household savings. Some savers willing to hunt for the best accounts could have done better.

Save time hunting with Active Savings

In contrast, over that period, the stock market turned £100 into £432 before costs. This works out to £284 after inflation.

Past performance isn’t a guide to the future though, and it hasn’t been a smooth journey, with lots of ups and downs along the way.

Cash vs Shares (adjusted for inflation)

Past performance is not a guide to the future. Refinitiv Datastream, ONS, HL, 18/08/20.

The trade off

This is ultimately a trade-off.

In the long run, we’d expect the stock market to outperform cash most of the time. But unlike cash held with a bank, markets can fall as well as rise in value and you could get back less than you invest.

This is called a “risk premium” – the extra potential returns you can get by taking more risk.

The longer you can leave your money invested the greater the chance you outperform cash and recover from any short-term market falls. The graph above includes these, such as the 2008 Financial Crisis and the Dot Com Bubble in 1999/2000.

According to the 2019 Barclays Equity Gilt Study, the stock market has outperformed cash in 69% of two year periods, but 91% of 10 year periods.

This is why we think money you might need in the next five years should be held as cash. If you won’t need the money for at least five years then investing some of it in the stock market might be a good option. It could give you a better chance of outperforming inflation and meeting your financial goals in the long run.

The best way to invest?

It’s important to consider tax when investing. After all, the less tax you pay, the better your returns.

The government currently offers attractive tax breaks to encourage us to invest. It makes sense to take them up on the offer, before they change the rules – which happens regularly.

A Stocks and Shares ISA is a tax efficient investment account that allows investors to avoid some of the hardest hitting taxes – UK income and capital gains tax. Investing in stocks outside of an ISA when you have ISA allowance available can be a bit like making a voluntary donation to HMRC.

This tax year the maximum amount you can put into an ISA is £20,000. So you can shelter a significant amount of your investments from future tax, how much you benefit will depend on your circumstances.

You can open or top up an HL Stocks and Shares ISA with £100 or with a £25 monthly direct debit.

FIND OUT MORE ABOUT STOCKS AND SHARES ISAs

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