Financial Planning update: Cash vs Equities?

Interest rates remain at highs not seen for almost two decades, and with inflation continuing to prove difficult to control and on-going uncertainty on the future of prices, the prospects for a reduction in interest rates has subsided, with some banks even increasing mortgage rates in recent weeks.

With generous savings rates and no risk to the underlying capital (assuming the underlying institution remain solvent), the option of holding money in cash appears more appealing than it has done for some time. But what are the risks in doing so?

To fully understand the attractiveness of the return on cash savings it is important to factor in inflation to calculate the ‘real return’ being generated. Inflation is the measure of how much prices are increasing, meaning in order for a real return to be generated, the interest rate being paid needs to be higher than inflation.

Detailed below is a comparison of the Bank of England base rate compared to inflation since March 2009:

The above illustrates how seldom interest rates exceed inflation and a real return provided on cash balances.

Whilst holding some funds in cash to meet short term expenditure is absolutely sensible, the chart above illustrates the risk of holding significant funds in cash over the medium to longer term, with inflation eroding the value of these monies on a consistent basis.

If you are unlikely to require funds in the short term and are able to commit the monies over the medium to longer term, it may be sensible to consider investing these funds, with an element of risk to the underlying capital, though with the view of achieving a better, real return.

Detailed below is a chart showing how often stocks and cash have provided a real return in excess of inflation over varying timeframes.

As you can see from the graph, the results are quite notable, and shows that as the timeframe increases, the likelihood of the stock market providing a real return in excess of inflation, increases significantly, meanwhile the likelihood of this being achieved in cash has never exceeded 66% of the time.

As such, like many things it is important when planning cash and capital balances to think beyond the headline number quoted, and to consider your objectives and likely timeframes for holding the underlying funds.

Please contact the team for further expert advice.

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