With cash earning 5%, why risk money on the stock market?

Savings rates have trebled in 12 months, and UK savers can earn over 5% on one-year deposits. So doesn’t it make sense to cut risk and stick to the safety of cash?

14/06/2023
equity_market_June_22

Authors

Duncan Lamont, CFA
Head of Strategic Research, Schroders

Cash savers are benefiting from the highest returns in almost two decades, with some popular accounts like cash ISAs currently paying over 5%. The rise in returns has been rapid, with rates today many times higher than a year ago. Unsurprisingly savers are committing more to cash ISAs than at any point in the past five years*.

After a long spell in which nominal returns on cash were virtually zero, investors are now rethinking the role deposits should play in wider portfolios. Schroders’ May 2023 survey of financial advisers – coming as the Bank of England raised interest rates for the 12th time since the start of 2022 – found nine in ten advisers were “having conversations with clients about long-term investing versus cash deposits”.

Aren’t investors right to reconsider cash?

All savers’ circumstances are different, and some may have excellent reasons to be holding cash. But just because savings rates are rising does not mean cash is keeping pace with inflation.

Popular UK savings rates vs inflation

Cash ISAs

Jan 2022

June 2022

Jan 2023

30 April 2023

Variable rate

0.3%

0.6%

1.7%

2.3%

2-year fixed rate

0.5%

1.6%

3.9%

4.1%

Inflation

5.5%

9.4%

10.1%

8.7%

Source: Bank of England; ONS, June 2023

As shown, cash returns after inflation – or “real” returns – remain negative, even though rates have risen strongly. Negative returns mean losses. And the jump in inflation since early 2022 means that the value of cash is now eroding at a faster pace than for most of the previous decade, even if the cash earns today’s top available rates.

So for many the key question of where to make long-term investments remains as relevant as ever. In fact it is even more important.

Cash or equities: what are the chances of beating inflation?

The certainty offered by cash lies only in its nominal value. £100 today will still be £100 in future years. There is no certainty its spending power will hold up, however. Low inflation will see the money retain its spending power to some degree, but high inflation will erode it quickly.

Time is the critical factor. Over short periods cash is likely to fare better against inflation. Over long periods, cash fares worse, even where inflation is relatively low.

The chart below crunches historic returns on cash and stock market investments over a range of timeframes extracted from 96 years’ data. It then sets these against inflation over the same timeframes.

Cash vs equities

The results are stark. The chart shows that over very short periods – three months or less – there has not been much difference in the likelihood of cash or shares beating inflation. But for longer periods the gap widens conclusively.

  • The likelihood of cash savings beating inflation has been about 60:40 for the majority of all timeframes.
  • The likelihood of stock market investments beating inflation has reached 100% where the investments are held for 20 years.

In other words, for every 20-year timeframe in the past 96 years, equities delivered inflation-beating returns.

So while stock market investments may be risky in the short run, when viewed against inflation they have offered far more certainty in the long run.

The stock market has delivered strong long-term returns through very different conditions

The recent era of ultra-low interest rates, from which we’re now emerging, has meant that cash has been unattractive for investors. That is despite the fact that inflation until recently has been low.

Cash vs equities

In the past five, ten and 20 years, cash savings have failed to keep up with price rises and so depositors would be worse off.

Over very long periods – during which inflation and interest rates have gone through both highs and lows – cash has retained its spending power, but only just.

By contrast, stock market investments have delivered inflation-beating returns over all periods highlighted in the chart.

So it’s a no-brainer: stock market investments are a better bet for long-term real returns?

There are lots of reasons to hold cash, and savers’ individual timeframes will differ. For many, this is where financial advice will be invaluable.

While long-term historic data strongly suggests stock market investments stand a better chance of beating inflation than other investments, they are also volatile.

So investors who opt for stock markets over cash need to be prepared for a bumpy ride.

Cash vs equities

  • In approximately half of the past 50 years markets fell by at least 10%.
  • In a quarter of the past 50 years markets fell by at least 20%.

In conclusion, different risks attach to both cash and stocks and shares. Cash is far from a risk-free asset: even at today’s best available savings rates, deposits are likely to lose real value. And, as our data shows, cash can deliver real losses over longer periods too, including the past two decades. But shares also carry risk, especially when held for shorter periods.

*Source: Bank of England, two-year fixed rate cash ISA, change from 30 April 2022 (1.19%) to 30 April 2023 (4.12%). ISA deposits from BoE Money & Credit tables. Data issued June 2023.

This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. 

Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.

This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.

All data contained within this document is sourced from Cazenove Capital unless otherwise stated.

Authors

Duncan Lamont, CFA
Head of Strategic Research, Schroders

Topics

The value of your investments and the income received from them can fall as well as rise. You may not get back the amount you invested.