Jekyll and Hyde features of cash

Holding too much cash can be wealth destroying. George Uglow warns of the consequences of not investing in capital markets. 

Cash is the Dr Jekyll and Mr Hyde asset class of the investing world. It is good that Dr Jekyll moments for cash tend to come at times of market turmoil, such as in 2022, when bonds and equity markets both fell.

The opposite, evil Mr Hyde persona is cash’s terrible track record of maintaining or growing purchasing power over time for investors. 

As an example, if we look at how cash performed during the Global Financial Crisis (2007-2009) and how it has performed since then compared to world (developed and emerging) equities, we can see it is a poor store of long-term value. 

Over the whole period, 27% of its purchasing power was eroded, while ‘higher-risk’ equities’ purchasing power more than doubled, even when measured from the height of the market before the fall.

No signal

It can feel tempting to want to hold cash that pays a seemingly decent rate of interest, but the problem is that no one gives you a signal telling you when to get out of risky markets and into cash or when to get back into markets. 

As John Bogle, founder of Vanguard Group and one of the ‘grandfathers’ of index investing, said: ‘The idea that a bell rings to signal when investors should get into or out of the stock market is simply not credible. After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. 

‘I don’t even know anybody who knows anybody who has done it successfully and consistently. Yet market timing appears to be increasingly embraced by mutual fund investors and the professional managers of fund portfolios alike.’

In 2022, bonds and equities both fell, driven to a large extent by the rapid rise in inflation to double digits and the subsequent increase in both bank base rates – controlled by central banks – and bond yields – driven by the market’s need to be compensated for risks taken on. In this situation, some investors were tempted to retreat to cash. 

After all, deposit holders could receive, say, 5% or so on their cash, so why bother with bonds or even investing in general?

Long-term premium

Answering the bond question, it should be remembered that, on average – as with placing a bank deposit – the longer you lend your money for, the higher the interest rate or yield in the case of bonds. For lending is what you are doing when you give the bank your money or buy a bond. So, for a long-term investor, this ‘term’ premium should provide a small higher expected long-term return. 

In addition, often but not always  at times of equity market crisis – 2022 being a case in point – money tends to flood out of risky assets and into high-quality bonds, driving prices up. 

In this case, investors receive both capital gains and yield. This provides a defensive element not available to those holding cash, who just receive the interest they are paid.

Perhaps something also worth noting is that it is very difficult to second-guess where bond yields will be in the future. There is quite a bit of talk in the media that interest rates – being the Bank of England base rate – may come down in the next year. 

That is in each central bank’s control. Bank deposit rates are generally set relative to this rate. Bond yields, on the other hand, are driven by the market’s aggregate view of the risks it perceives, which will already incorporate its own collective view on where the bank base rate will be in the future.  

It is not the case that bond yields will fall just because the bank base rate is reduced, as that is already anticipated to some extent and reflected in bond prices today. No market timing bell there.

Few winners 

Trying to second-guess the market is a challenging sport with few winners. In the US, for example, over 90% of government bond funds failed to beat their market benchmarks over a ten-year period.

Data shows us that investing makes sense. As long as you take advice while maintaining sufficient liquidity and contingency funds, then there is no need to hold excess funds in cash reserves. 

In terms of not investing at all, there is much evidence as to why long-term investors should avoid holding cash in lieu of investing. 

If we look at the evidence since the start of 2023, an investor holding cash, which may have felt comfortable at the start of 2023, would have left valuable returns on the table.

George Uglow (right) is a chartered financial planner with Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS

The content of this article is for inform-ation only and must not be considered as financial advice. Cavendish Medical always recommends that you seek independent financial advice before making any financial decisions.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The value of investments and the income from them can fluctuate and investors may get back less than the amount invested.