Cash has delivered better returns than investments over the medium term, claims a new study from BBC Moneybox presenter Paul Lewis.
Comparing returns from “actively managed” savings to those from a FTSE 100 index tracker fund over the last 21 years, the research undermines the widely held belief that investments usually outperform savings over longer time scales.
It found that over any given five year period since 1995, money held in top one year fixed-rate savings accounts delivered better returns than the tracker 57% of the time.
“This analysis of the new data shows that people who prefer the safety of cash can make returns that beat those on tracker funds in a majority of time periods,” says Mr Lewis.
“It also confirms that the risk of making losses on when investing in shares is very real. Over any investment period from one to five years from 1995 to 2015 there was about a 1 in 4 chance or greater that the value of the investment would fall. Even over nine or ten years the chance of losing money was around one in ten.”
However, the analysis assumes the saver switched their money between the best accounts each year to get the best rate, what Mr Lewis calls ‘active cash’.
Some investment advocates have challenged this – highlighting in practice it can take a week or two to transfer money between accounts, and that it’s a pain for savers to keep switching their money around.
“The idea of ‘active cash’, whereby savers continually move their money between best buy accounts, is a very appealing idea, but is difficult to achieve in practice right now,” says Laith Khalaf, senior analyst at Hargreaves Lansdown.
So should we ditch our investments and switch to savings?
On balance, probably not, though the research does give food for thought.
The most obvious point to take from the cash crusader’s research is that warnings of possible investment losses are very real, and should be taken seriously.
If the idea of the value of your investments falling by half, if only temporarily, brings you out in a cold sweat, then you should probably stick to saving. Up to £75,000 savings with any UK licenced bank is protected by the Financial Services Compensation Scheme, and there’s no risk that you’ll end up with less than what you put in.
The second point is that while it’s still true that investments tend to do better than savings over the long term, the time it takes for investments to reliably outpace cash is considerably longer than most people think. Even over ten years, investments’ chances of winning improve, but they still only beat cash half the time.
But if you go longer still, and look at a 20 year period, Mr Lewis’s figures show the FTSE 100 tracker fund beat cash every time.
The chances of losing money with investments also fall as your timescale increase, but you’d need to have invested for at least 12 years to eliminate the chances of investments being worth less than you started with.
The second point is that while it might be true that savings have done better over five years most of the time, the research underplays how much better investments can do during a purple patch.
Based on Mr Lewis’s research, the best five year period for savings delivered about a 45% return – but investors could have seen their money rocket 150% during the best five year run, starting in January 1995:
Whether the potentially bumper-returns are worth it for you will depend on how happy you are to take the substantial risk that your investments will fall, but to reiterate, the longer you can wait, the more likely you are to be rewarded for your patience.
Is it a fair comparison?
The third point is that the research arguably doesn’t compare like-for-like, pitting the best savings accounts against an average FTSE 100 tracker. Wouldn’t it be fairer to compare the best savings accounts to some of the best investment returns?
Active managers offer this possibility, with investors paying higher fees for the possibility of much higher returns. Could they do better?
In the 21 years since 1995, savings accounts have typically delivered 5% growth per year. To put that another way, if you’d put £10,000 in the best account and moved it each year, you would now have £27,860. That’s pretty good – you’ve almost tripled it.
But if you’d given it to star fund manager Neil Woodford, he would have grown your money by 12.9% a year, and your £10,000 would now be worth £127,812, even after paying higher active management fees.
There’s a big problem with this though. While in theory it might be worth paying fund management fees to someone who delivers better returns than a tracker fund, in practice it’s impossible to pick the best actively managed fund without the benefit of hindsight.
Worse than that - most fund managers fail to beat passive funds over the long term, so there’s a big risk of paying higher fees for worse performance. Even the top managers, with a strong track record over many years can go through periods of severely underperforming against the market at some point in their careers, and you won’t see it coming until it happens.
That’s why I like tracker funds. Unlike potential returns, fees can be compared much more easily, and cheap funds mean you give less of your money away each year.
However, that’s not to say the battle is over, and cash has won – after all the FTSE 100 isn’t the only option for investors.
Mr Lewis’s research also compared cash returns against a FTSE 250 tracker fund. This follows the average performance of the less well known FTSE 250, which is made up of the next largest 250 companies on the London stock exchange, excluding the 100 largest (that’s the FTSE 100).
Generally, investing in medium-sized companies is seen as higher risk than larger ones, but with higher risk comes the possibility of better returns. To see how an investment in the FTSE 250 fares against cash we need to start in 1998, as FTSE 250 trackers weren’t available in 1995.
The results show that not only has the mid-cap index delivered bigger overall returns than the FTSE 100 or cash since 1998, but also it has done so more consistently, outperforming cash two-thirds of the time when investing over five years.
Don’t ditch everything to buy a FTSE 250 fund though – it’s been an unusually good period for the index, which is unlikely to be repeated over the next 20 years. It does go to show the importance of diversifying your investments though – if you’re investing you don’t want to put it all on the FTSE 100.
If you’re thinking about investing the research really hammers home some principles every investor needs to understand:
- The chances of losing money on investments are very real and if you can’t accept that, you shouldn’t invest
- Returns from investments over cash can be exaggerated if you don’t consider the fees you pay
- Over the longer term, investments are more likely to do better than savings, but even if you invest for 10 years, there’s a very real chance you’d have been better off in cash.