It's an understandable question to ask yourself as interest rates available on cash and term deposits begin to approach the long term average returns from a portfolio in which you would have had to bear the underlying risks of investing.

Your plan needs a relative return in the long-term, not a nominal return in the short term.

Once the decision has been made on whether funds should be saved (for short term calls, emergencies or opportunities) or invested (for funding the future beyond 3-5 years), the objective with the invested pot will almost certainly be to deliver an inflation beating return.

The chart below shows how over the long term, a balanced portfolio has been a far better tool for this job than cash (short term Treasury Bills being used as a proxy here).  It's not just by fortune, there are many fundamental economic reasons why you should expect a higher return from stocks and bonds over cash.

There’s no free lunch in investing.  With a higher expected return, comes a higher chance that you don’t have a successful outcome.  This has been evident within the last couple of years as inflation has outstripped what investors have received.

I get that, but why not bank 6% now and come back later?

The chart above speaks for itself.  Investing will very likely result in an inflation beating outcome whereas cash has had very many long periods of time where it has fallen behind.  

Even now inflation in the UK (RPI - 6.4%) exceeds the rates of interest available from cash accounts.  By moving from portfolio to cash, you lock in this outcome (and in some cases guarantee a relative return that is insufficient to deliver your plan) rather than being in a portfolio which has the potential to deliver the returns you need.

6% does look a tasty return to be banked with certainty now I will admit, particularly after over a decade of next to nothing on savings.  The problem comes in the market timing.  When to exit a portfolio for cash and when to come back again?  

Unfortunately portfolio returns are not delivered in smooth equal tranches month in month out.  The average return we are looking for, is the amalgam of all of the up days and down days in our investment lives.  Some of those up days contribute a massively disproportionate amount to your return, and by missing them, you can savage your return as the chart below shows.  

The second problem arises in that noone knows when the good and bad days are coming so you’ve got to be in it to win it!

Then there’s the Tax…

Setting aside the tax wrappers such as pension and ISA, a directly held portfolio will typically be taxed more favorably than a savings account.  Capital Gains Tax is currently 20% for higher rate taxpayers, with interest on bank accounts being taxed at 40%.  Once tax is factored in, the number of periods in which cash has delivered an inflation beating outcome is reduced even further.

To conclude, we are not advising our clients to move to cash as you would expect.  It is not the first time we have experienced low portfolio returns and high inflation.  There’s nothing that has fundamentally changed about one of the key pillars of our investment philosophy - risk and return are related.  If you want an increased return you must take on risk and this means uncertainty of outcome, particularly in the short term. 

bdb investors should rest assured that their portfolios have sufficient power to deliver the inflation beating returns their plans need in the long term.

Posted by: Matthew Kiddle | Posted in: News