Saving cash is a poor choice in the long run

Published by Jeff Prestridge on 01 March 2016.
Last updated on 01 March 2016


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

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