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  • Cash vs investing – where should investors look when the interest rate cycle turns?

    With the interest rate cycle nearing its peak, we look at cash versus investing in the stock market, and where investors could look for opportunities.

    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

    This article is more than 6 months old

    It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

    This year has been a two-horse race when it comes to asset allocation. Investors have been going for the quintessential bar-bell approach – all risk and low risk – of tech stocks and cash.

    Third quarter trades on our platform revealed investors have been buying plenty of money market funds and exchange traded funds (ETFs). But also NASDAQ and tech trackers and a few US share and developed market options – also chock full of big tech.

    Money market funds have been a consistent fixture in the top-buys lists this year – and that’s a concern.

    This article is not personal advice. Unlike the security offered by cash, all investments and any income they produce will rise and fall in value, meaning you could get back less than you invest. If you’re not sure an investment is right for you, ask for financial advice.

    Don’t get me wrong. Cash has an important part to play in your financial resilience. Three to six months’ salary is the rough guide for your rainy-day fund to cover emergencies. You can use a cash savings platform like Active Savings and that emergency pot can be easily managed in one place, maximising interest opportunities while offering peace of mind.

    Cash can also be a great tactical tool to have in a portfolio – in a rising interest rate environment coupled with stock market volatility, you can be rewarded for keeping your powder dry and make use of it when the right opportunities arise.

    But cash has limited long-term strategic asset allocation benefits, particularly if you’re still in the accumulation stage of your life, i.e. not yet retired. (Retirees should be looking more to finely balance capital preservation and income, but often care less about growth, so cash can have some benefit to these investors).

    Cash versus shares – how have they fared over the long term?

    Your money might not be at risk as cash, but it also never grows. Cash just doesn’t pay over the long term. Even in a stock market slump, it’s usually better to ride the market through the downturn and hopefully up an eventual rally.

    The US stock market has fallen by more than 25% 11 times – and taken on average around two years to recoup losses. Cash on average took twice as long. Over the past 10 years, the US stock market is up 290%, where cash has returned 8.6%.

    The biggest companies on the UK stock market similarly trounces cash over the long term. Despite our domestic market facing regional headwinds – Brexit, lack of tech stocks, political turmoil – it would’ve still delivered a total return of 64%. Remember, past performance is not a guide to future returns.

    It’s easy to see why cash has appealed – the Bank of England base interest rate has risen 5,150% in the last three years and now stands at 5.25%. But this won’t likely be repeated.

    The top of the rate environment is difficult to call exactly, but it’s likely we’re not far from it. Some top paying savings accounts have been pulled or closed.

    NS&I pulls top 6.2% fixed-rate deal – where to look now?

    Will rates fall and where could investors look?

    Asset allocators are forecasting more attractive returns for bonds versus cash and are starting to tentatively look beyond the current interest rate environment.

    According to data from the Federal Reserve collated by JPMorgan, over the past 40 years, the median length of time between the last rate hike and the first cut is eight months. Of course, that doesn’t mean history will repeat itself, it could take longer.

    In a falling rate environment, you want bond funds – witness the near three-decade bull run in recent history – and shares, as the falling cost of capital spurs company spending. Dividends can also offer a real yield (potentially higher than inflation) and a boost to total returns. It should be remembered dividends are variable and not guaranteed.

    In preparation for when the cycle turns, it’s worth looking at what’s currently undervalued – we think Japan, the UK and emerging markets on a regional view, and consumer stocks, REITs and financials for global sectors.

    You could even think about taking any gains from areas that have done well recently, and diversifying into undervalued areas.

    It could also be worth considering moving away from money market funds into actively managed bond funds. That’s because these funds have the flexibility to take advantage of opportunities when the rate cycle starts to turn.

    And if all of this is too time consuming or complicated, outsource to a multi-asset fund.

    Time in versus timing the market

    Of course, the transition between the stages in the market cycle is rarely smooth. There will be ups and downs, and some assets will be hit harder. The triggers will be complex – the devastating casualties in the Israel-Hamas war have a market impact, or it could be rising oil prices, a political misstep, worse than expected jobs or growth figures, or simply stubborn inflation.

    And we know that perfect timing is near impossible – the recent annual Morningstar Mind the Gap report shows a negative investor return gap over the five years to the end of June 2023. That means investors' timing of entries and exits detracted value compared with a hypothetical buy-and-hold investment.

    But across multiple data points – versus inflation, in a rising market, in a downturn, over the five worst slumps of the past 100 years – for long-term financial goals, investing has delivered better returns than cash.

    It’s usually better to be early in your trade and sit out the transition volatility if you have financial goals that are more than five years away.

    One thing is certain in this uncertainty, eventually this trade will change, and it’s better to be ready for it – timing the market is near impossible, but time in the market helps secure your long-term financial goals.

    How to make the most of these opportunities?

    To help make the most of these opportunities, use our Wealth Shortlist to see which funds we think have the best chance of performing well in these areas and elsewhere over the long term.

    Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

    Explore our Wealth Shortlist



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      Important notes

      This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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