Investments

Cash vs investing

Colin Dyer

You may have seen financial journalist Paul Lewis’s article recently on the claim that “cash beats shares”. It was definitely an interesting read and a good reminder of the role that cash can play. However I don’t believe that we’d be giving investments their due without taking a closer look at how it all measures up.

 

The “cash beats shares” headline is based on analysis that compares the interest made on cash held in best buy cash savings accounts with the investment return from a FTSE® 100 tracker fund between 1995 and 2016. Paul found that money put into “active cash” (when you move your money into the best savings account each year so that you always get the top interest rates) beat the FTSE® tracker in 57% of the five year periods within that time.

Over the whole 21 year period the cash scenario produced an average annual compound return of 5% while the FTSE® tracker returned 6%. Yes, that means shares technically won over the long term, but not by as much as you might expect. And when investments have to compete with the safety of cash accounts, perhaps not by enough to make the investment risk seem worth it.

So does this mean we should just cash it all in?

Well, not quite. Having looked at the research there are some points I have to make in investment’s defence.

Choice of tracker

I thought I’d by start by looking at the context of Paul’s analysis, particularly his choice of the HSBC FTSE® 100 Index Fund. As a tracker, its performance should mirror that of the FTSE® 100, even though its returns won’t be an exact representation due to charges, the performance should still do well in a rising market and then follow the market down in a falling one. This is where the timing becomes so important. Since 1995 we’ve witnessed two sharp stock market crashes – the tech crash in 2000 and the start of the global financial crisis seven years later. Highlighting this provides some helpful context for the comparison, especially when you consider that almost nine years later economies are still recovering from the financial crisis.

In addition to the economic backdrop, I would question the choice of the HSBC fund. Over the 21 year period that the research looks at, the HSBC tracker achieved 107.62% less than the FTSE® 100, returning 244.21% compared to the FTSE®’s 351.83%*.

This is where we start to see why fund selection is so important…

Active management

When looking at investment performance in research like this, I think it would’ve been very interesting to look at actively managed funds as well. After all, the cash comparison used relies on people being ‘active’ with their savings and regularly moving it to the accounts with the best interest rates.

The “active vs. passive” debate is one for another time. However it is worth considering the value of active management as research by Citywire found that in the UK All Companies sector, 68% of fund managers outperformed the market. This figure only comes from looking at a 10 year performance history up to February 2016 so isn’t totally comparable with the cash vs. investing question, but it does emphasise the style of fund management as something else to consider.

Adding active management into the mix is an opportunity to realise the value good fund managers can bring, especially by achieving performance in all market conditions. Of course the problem with this sort of retrospective research is that past performance is never a guarantee of future results.

Diversification

But the purpose of this blog is not to simply throw figures at you! It’s to highlight the fact that cash and shares offer very different investing experiences and outcomes. Shares are risky. There will be good times and bad times. And within that, shares held in tracker funds will not (by definition) ever avoid the bad times.

That’s why diversification is so important. Cash and shares are basically at polar-opposite ends of the risk spectrum. No sensible investment portfolio invested for this sort of timescale is likely to be made up of 100% shares. A well-diversified, multi-asset portfolio spreads the risk across a range of investments including things like government bonds, which are normally viewed as safer investments. The allocation to each investment type is then dependent on your appetite for risk and your investment goals.

To highlight this FinalytiQ replicated Paul’s research with a simple Global 50/50 portfolio, (made up of 50% MSCI World Index and 50% Barclays Global Aggregate Index). The results showed that even a very basic level of diversification beat “active cash” over the majority of time periods.

Rerunning the research with a truly diversified portfolio would probably show very different results – however it wouldn’t be in keeping with the “cash vs. shares” headline! And creating a well-balanced, multi-asset portfolio isn’t straightforward – it requires a good understanding of the financial markets, which is where the value of advice comes in. A financial planner will ensure your investment portfolio is constructed to reflect both the level of investment risk you are comfortable with and your investment goals.

Rates and reward

I began by looking at the wider context of the research, but it’s also worthwhile looking at the context of the present market. Interest rates on cash are at historically low levels in the UK, especially after the Bank of England’s (BoE) most recent cut to a rate of 0.25%, a level that hasn’t been seen in the BoE’s 322 year history. So although cash gets rid of investment risk, it’s now likely to provide only very modest returns meaning that your financial goals might need to be pretty modest too.

That’s why being clear on what your goals are is so essential – your financial planner can then help you create a plan to achieve them that will take more options into account than just cash and shares!

“FTSE®” is a trade mark jointly owned by the London Stock Exchange and The Financial Times Limited and is used by FTSE under licence.

The information in this blog should not be regarded as financial advice. Past performance is not a guarantee of future return.  Multi-asset portfolios are investments and have varying degrees of risk. Please remember that the value of your investment can go up or down, and may be worth less than you paid in.

*Data and comparison by FinalytiQ