Why cash may be riskier than you think

2022 was one of the few years when cash performed better than both stock and bond markets. It is perhaps not surprising that a recent survey of financial advisers by Schroders, Cazenove Capital’s parent company, found that many were “having conversations with clients about long-term investing versus cash deposits.” Today, UK savers can get a return of over 4% on cash deposits. After the volatility of recent years, this low-risk return may look tempting – especially after a rally in markets that has helped recover some of last year’s losses. However, holding onto, or switching to cash instead of investing is a risky strategy. A multi-asset portfolio still looks more compelling for long-term investors. 

Instinctively, many of us tend to think of “risk” in terms of the amount that prices move – or volatility. It is certainly the case that markets come with more of this kind of risk. But as wealth managers looking after clients’ assets for the long term, we also have to guard against the risk of failing to protect capital against inflation – and jeopardising its future purchasing power over the longer term. It is here that cash falls short.

There will be situations where clients need to hold cash or very low-risk investments – for example, to meet day-to-day living expenses or a known liability such as a tax bill. However, even in these cases, cash in the bank may not be the most attractive option. We explored some of the other possibilities here: How can you benefit from higher interest rates?

1. History favours investors over savers

While returns on cash have risen significantly in recent years, they are still well below inflation. In fact, the UK Base Rate has not consistently exceeded the UK’s inflation rate since the eve of the financial crisis of 2008/2009. Given that rates on cash are generally lower than the Base Rate, the true picture has been even worse for savers.

Almost a decade and a half of negative real returns for savers

UK Base Rate vs UK CPI

^{Source: Refinitiv Datastream}

Below, we show a summary of returns of major UK and US asset classes over almost 125 years and 100 years respectively. This long-term market data provides compelling evidence that investing in shares is the best way to grow the value of your capital ahead of inflation over the long term. In both markets, equities underperformed cash last year. However, over all other time periods they have offered a return that is both ahead of inflation and comfortably ahead of cash and government bonds.

UK real investment returns by asset class (% pa) since 1899

US real investment returns by asset class (% pa) since 1925

Past performance is not a guide to the future and may not be repeated

^{Source: Barclays Equity Gilt Study 2023. * denotes entire sample.}

Of course, the track record is not perfect. In any given year, equities can and do underperform both inflation and cash – as we saw in 2022. This can also extend to longer periods of time. Looking at the US data from a slightly different perspective, we see that stocks have beaten inflation in 77% of 5-year periods over the past 96 years. That means that in 23% of five-year periods they have not. The odds move more definitively in favour of equities when looking at 10 and 20-year periods.

Risky in the short run, less in the long run

Percentage of time periods where US stocks have beaten inflation, 1926-2022

Past performance is not a guide to the future and may not be repeated

^{Source: Morningstar Direct, accessed via CFA Institute and Schroders. Stocks represented by Ibbotson® SBBI® US Large-Cap Stocks. Data January 1926-December 2022}

As our disclaimer notes, there is no guarantee that the performance of equities will be repeated in future. However, it is worth bearing in mind that over the long-term equities’ performance tracks corporate profits which are in turn a function of global economic output. Both have consistently grown ahead of inflation over the long run, despite wobbles in crisis years such as 2008 and 2020.

2. The importance of diversification

Investors are often warned not to put all of their “eggs into one basket.” In our view, this should extend to cash as well.

Cash does a good job when it comes to protecting capital against market risk, but offers far less protection against inflation. The reverse is true for equities. Holding a diversified range of assets allows us to get the balance that best meets your requirements.

This will likely include equities and cash. But we typically also hold bonds and alternatives, allowing us to optimise the balance of market risk and long-term inflation protection. We are able to access assets in both categories that are specifically designed to provide inflation protection – such as inflation-linked bonds and infrastructure.

It is also worth noting that cash is not entirely free of market risk, given that rates rise and fall in line with the Bank of England’s Base Rate. You may be able to get 4% today, but there is no assurance of this rate over the longer-term. Bond markets currently anticipate that the BoE will be cutting interest rates some time in 2024.

3. The difficulty of market timing

An investor could well accept the argument for long-term investment in a diversified portfolio – but still believe that he or she can successfully time the market over the short term. In other words, they believe they can identify a time period where cash outperforms other major asset classes. Again, we would be wary of such an approach.

There have been plenty of occasions over the past few years where markets have wrong-footed the savviest investors. A risk for anyone attempting this today is that inflation falls faster than expected and markets perform strongly. Those sitting in cash would miss out on the rally while prospects for future cash returns would dwindle.

For investors nervous about putting cash to work in one go, we typically adopt a phased investment approach. This would allow you to take advantage of any dips in markets over the coming months, while also ensuring that you do not entirely miss out on any rally.

To find out more about how we can help you with investment and wealth planning, please get in touch with your usual Cazenove Capital contact or wmteam@cazenovecapital.com.