Following the financial markets volatility of 2022, many people have wanted to seek out safer returns and, with numerous hikes in the base rate of interest, this is understandable.
However, is this really in someone’s best interest? There is, of course, no “one size fits all” answer but some considerations to keep in mind are:
Returns: Cash interest rates typically offer lower returns compared to long-term investing. While cash provides stability and immediate access to funds, the interest earned on savings accounts or cash investments is often modest – albeit rates have improved dramatically since early 2022. On the other hand, investing in stocks, bonds, or other assets has the potential for higher returns over the long term, although it comes with associated risks.
Dangers of reacting to a market fall: A study by 1Quilter plc suggests missing the 25 best days from 1992 to 2022 would have meant an initial £10,000 investment grew to £28,487. This is in contrast to remaining invested throughout the timeline where the same sum would have returned £121,213 – based on investments in global equities.
Of course, this is just an illustration of what happened, and one would likely be invested in other asset types for diversification purposes. Nevertheless, though reallocating capital to cash temporarily in the current market may seem the most economically viable solution, it may well end up being a very costly one.
Inflation: Inflation erodes the purchasing power of cash over time. If the interest earned on cash investments is lower than the inflation rate (which it often is in recent times), the real value of your money diminishes. Investing in assets that historically outpace inflation can help preserve and grow your wealth over the long term.
Risk tolerance: Cash deposits are considered low risk as the initial deposited sum is safe unless the institution incurs financial hardship such as Northern Rock. However, they may not provide substantial growth potential over the long term, despite recent improvements in cash deposit rates. Investing, on the other hand, involves varying degrees of risk depending on the asset class. Stocks, for example, can be volatile in the short term but tend to deliver higher returns over longer periods.
Time horizon: Investing is generally recommended for long-term financial goals, such as retirement or funding major expenses in the distant future. The longer your investment horizon, the more time your investments have to potentially grow and weather market fluctuations. This general principle applies even if you are drawing from them in the meantime. If you have short-term goals or need quick access to funds, cash deposits may be more appropriate.
Diversification: Investing over the long term allows for diversification across different asset classes, industries, and regions. By spreading your investments, you can reduce the risk associated with any single investment. Cash investments, while generally safe, lack the diversification potential of investing in a broad range of assets.
Ultimately, it’s often wise to allocate capital so you have both cash reserves for emergencies and investments that align with long-term objectives. Consulting with a financial adviser at Wingate can provide personalised guidance based on your specific situation as every situation is unique.
