Saving cash is a poor choice in the long run
Cash is King. Well, it always will be in the eyes of many, even if the rewards from holding it over the past seven years have been non-existent.
It’s an understandable personal finance trait, especially given the volatile state of world stock markets this year. Better to hold cash whose face value is guaranteed than leave your money at the mercy of stock markets.
Yet cash is not king in my eyes. Not at all. Of course, we all need to put money aside in case of a financial emergency, to pay our tax bill or to fund a much needed holiday to the Seychelles.
But if we want to build long-term wealth – preferably through the tax breaks offered by pensions and individual savings accounts (Isas) – cash won’t do it. We need to look at other financial assets to deliver us the Holy Grail, even if it means a rocky journey along the way.
That means a mix of property (commercial and residential), bonds and equities.
I recently asked Adrian Lowcock, head of investing at financial company Axa Wealth, to do some number crunching for me. His results are revealing – and should shock some deposit savers to question their financial strategy.
Taking March 2009 as his starting point – the date at which base rate in this country dropped to 0.5% – he calculates that the overall return from holding cash over the subsequent seven years has been a meagre 5.42%.This assumes the money (£5,000) has been saved in an ‘average’ paying instant-access account.
All fine and dandy on the surface. But once inflation starts to be taken into account, the numbers look far less impressive. Mr Lowcock says that since March 2009 inflation has eroded the value of cash savings by more than 17%. In other words, a mix of record low interest rates and persistent nagging inflation have wreaked havoc with people’s cash savings in the bank or local building society.
To put all these numbers into perspective, since March 2009, the FTSE 100 Index (the stock market barometer of the country’s top 100 listed companies), has generated a total return (all dividends reinvested) of more than 107%. This is despite a 13% fall in the FTSE 100 Index in the past year, triggered by plunging commodity prices, China’s economic situation and growing fears of a world financial crisis to match that of 2008.
Looking forward, it’s unlikely that returns from cash will improve for quite a while yet.The Bank of England is reluctant to push up base rate while economic recovery remains so fragile. As a result, it could well be not until 2018 before a rate rise is sanctioned. Even then, any increase is unlikely to feed through straightaway into better savings rates.
It’s not surprising that Mr Lowcock is now talking about a potential ‘lost decade’ for savers – 2008 to 2018. At the very least, savers should be ensuring they are earning the maximum interest on their deposits.
At best, they should be moving some of their hoarded cash into investment funds that can generate them real long-term returns, preferably sheltered from further tax by being held inside an Isa.
I’m a big believer in using investment-based Isas to build long-term wealth.The annual allowance – £15,240, both this tax year and the next starting 6 April – is more than generous. Indeed, there is even an annual allowance of £4,080 for your children.
The best strategy is to squirrel money away on a regular basis, money that you can afford to miss and would otherwise fritter away. Adopting this approach, it’s surprising how quickly you can build wealth.
If you are still not convinced by the argument for investing over saving, let me conclude by referring to some detailed analysis conducted by Credit Suisse Asset Management. Analysing the performance of different asset classes over the past 115 years, it concludes that the ‘real’ annual return from UK equities (the return above inflation) has averaged 5.3%.
In contrast, the annual returns from bonds and cash are lower at 1.6% and 0.9%.The authors see no reason why real returns from equities cannot progress at between 4% and 6% a year.
The message is clear. Stop saving. Get investing.
Read Jeff Prestridge's views on why equity release plans are a sensible option for cash-poor property owners and his views on George Osborne's treatment of pensions.
Or you can read all of Jeff’s previous columns here.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
A term to describe financial products or ‘plans’ that help older homeowners turn some of the value (equity) of their homes into cash – a lump sum, regular extra income, or sometimes both – and still live in the home. There are two main types of equity release: lifetime mortgages and home reversion plans (see separate entries for both). Whichever type you choose, you borrow money against the value of your property, on which interest is charged, and the loan is repaid when the house is sold after your death.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.