For much of the period since the 2007-08 financial crisis, savings accounts were barely worth it. Ultra-low interest rates meant limited or negative real returns on cash, at a time when stocks and bonds generally marched higher.
But now, even dyed-in-the-wool stockpickers will struggle to ignore the lure of the savings market. In the UK, you can lock in interest rates of 6 per cent on fixed-rate bonds of between one and three years, and even 5 per cent from some easy-access accounts.
By giving up between 25 and 50 basis points, savers can shelter interest from tax in a cash Isa. Max out your allowance, and gilts’ exemption from capital gains tax offers comparable near-guaranteed returns from medium-duration government bonds, providing you hold to maturity.
This substantially raises the bar for equities’ performance, in both absolute and inflation-adjusted terms. Put simply, stocks’ earnings yields must exceed 6 per cent just to match the sleep-easy options now available. Realistically, they need to do much more than that, to both preserve capital values and account for their extra inherent risk.
Fortunately, their historic record is reassuring. According to Barclays’ 2023 Equity-Gilt Study, real returns on UK equities have averaged around 4.5 per cent over the past 50 years, compared with 2.4 per cent from gilts and 0.7 per cent from cash.
Market assumptions also augur well. Consensus forecasts put the FTSE All-Share on an earnings yield of 9.1 per cent for 2023, rising to 10.4 per cent by 2025. In the US, where growth is typically stronger and valuations higher, things are more finely poised. If estimates prove accurate, investors in the S&P 500 can expect to see an earnings yield of 4.9 per cent this year, and 6.2 per cent in 2025.
Then again, conjecture isn’t as comforting as a contract. As is always true, we don’t know if current earnings expectations are too optimistic or pessimistic. If trend is a guide (and it might not be), there are reasons for both hope and doubt: while forecasts for US blue-chips have been climbing, earnings estimates for the commodities-heavy FTSE have dropped over the past 12 months.
Still, the pro-cash thesis isn’t watertight. One reason for this is precedent. The Barclays study found that over any two-year period since 1899, the probability of cash outperforming equities was 30 per cent. Over any 10-year window, this falls to 9 per cent.
That gets to the heart of another issue with big asset allocation decisions: to work, they require good timing. Now might be one such moment for cash. But the close relationship between inflation and interest rates means the real return on cash is rarely if ever stellar. If you lock in 6 per cent today and inflation hovers at its current level of 6.4 per cent, then real returns will be negative.
Another consideration is currency. To most UK investors, ‘cash’ means sterling, which in practical terms is whatever assets or goods sterling can buy.
This year, rising interest rate expectations have pushed up the value of the pound, thereby increasing the global purchasing power of sterling holders. In the longer term, the picture is less encouraging: since the start of the century, the pound is down 27 per cent on the euro and 23 per cent against the dollar. Between a persistent current account deficit, rising government debt, rising demands on the state and sluggish economic growth, it’s hard to believe the pound will escape further pressure. By contrast, the earnings of global equities (and fixed income) can spread this risk.
Granted, for all but the most gung-ho of investors, an allocation to cash or fixed income of at least 15 per cent feels sensible. Ultimately, however, their real risk is opportunity cost.
Faced with an unknowable future, the big choice for most investors is unchanged. Namely, how much to embrace the sharp end of a market economy, in which disruption – whether pandemic-like external shocks, or productivity-enhancing technological breakthroughs – magnifies both risk and reward, forcing adaptation and reinvention along the way. That’s a quality that cash can never offer.
