Cash vs shares: Why it still pays to invest…
As the Bank of England announces yet another interest rate rise – its eighth in the past year – people are starting to question whether it still pays to invest. The simple answer is unequivocally yes. While it makes sense in the current climate to bolster cash reserves to help weather the market fluctuations, it’s important to stay invested. Let’s take a closer look as to why.
First and foremost, we need to see cash and investments as two very different things. They not only perform in very distinct ways (with pros and cons on both sides), they perform very distinct roles from a portfolio perspective. Ultimately, cash is for short term spending goals and as a buffer, while your investments are what will help you live the life you want to long term. You need both in the right quantities to achieve financial freedom.
Shares outperform cash long term
As financial planners, we look at the whole picture of someone’s financial situation and plan by focusing on their long term financial and life objectives, while making sure they’ve got their short term financials covered.
With this in mind, if we look at long term performance, shares outperform cash the vast majority of the time. Whether you’re looking at 5, 10 or even 15 years, the trend is the same – in fact, the longer the time, the more likely it is that shares will have outpaced cash. What’s more, shares have stayed ahead of inflation over time too. You’d think therefore, that we’d all invest in shares (equities) 100% of the time, but we don’t. And for good reason.
Investing in company shares is riskier than cash – the returns are unpredictable, uncertain and not always guaranteed. Performance also fluctuates to a much greater extent compared with cash, making it harder to plan and, let’s be honest, hold your nerve when markets drop.
Cash is your short term safety net
Having cash meanwhile is a guaranteed return and is much less volatile. With interest rates running at less than 1% for the 13 years to mid-last year, the idea of holding large amounts of cash was totally non-sensical. But now, with the base rate now 5.25% and predicted to continue to rise to over 6%, it’s becoming more appealing. Where can you find investments that guarantee a return of that level? Why is cash now not the shrewd choice?
Again the answer is simple. Because it won’t last and thus it’s a short-term position. It’s really useful that cash is paying a higher rate of return and it provides savers with something to cheer about after so long. We advocate for clients to look at what return their cash is earning and discuss strategies of how to earn better returns on that cash. However cash is still guaranteeing a loss of purchasing power against inflation (still running at c8%).
As per the above, shares outperform cash long term. When investing into equities for growth it must be thought of as a longer term investment. The stock market goes up 75% of times in any one year, 80% over any five years, 90% over any 10 year and there hasn’t been a period where it hasn’t gone up over 20 years. This means that the longer you invest, the better the chances of long term wealth creation.
The end result is that you need both. You need cash to meet your spending goals and to protect you when times get tough, but you don’t want to overstate the amount you need because long term, it will be your investments that perform and ultimately make financial freedom a reality.