Beware the fickle allure of cash
What impact does inflation have on your wealth? Samuel Kirton explains why investing can deliver inflation-busting returns.
Most of us are all too aware of the challenge of inflation when we get to the supermarket checkout or when paying our energy bills.
Inflation does not only affect the spending power of our income today, but also the real value of our assets – for example, investment portfolio assets – that will deliver future spending power, perhaps in retirement.
While most people understand the nature of this hidden tax, it may surprise many just how big the impact of the inflation headwind has been over the past few years.
If we look at the impact of inflation on the spending power of £100 over the past 20 years, we can see that even when inflation was relatively low, it silently whittled it away.
On average over the last 20 years, inflation has been around 2.8% a year, which does not sound too bad. In fact, this means more than 40% of our spending power has disappeared.
The £100 from 2003 would be worth around £58 in 2023, according to the Office for National Statistics (ONS).
What is to be done?
For those doctors building a pot for retirement, protecting your wealth from inflation – and hopefully growing its real, after-inflation value – is very important.
The first thing to do is to become an investor, not a saver. For some, elevated deposit rates returning above-inflation interest may look appealing. Unfortunately, cash has had a very poor track record of holding its real value.
On the other hand, global equities (‘stocks and shares’) have managed to provide positive real returns for investors over the past 20 years, which includes the equity market turmoil in 2007-09 during the global financial crisis, and 2022.
That £100 in 2003 might have been worth £384 in 2023, with a period high of £413 in 2021.
Owners of equities, however, require staying power, as these positive inflation-beating returns do not come in straight lines.
Data from that same 20-year period shows us that the longer an investor is able to hold their equity investments for, the greater the chance that they will receive positive, after-inflation returns.
Things to remember
The allure of cash is clearest during times of market turmoil when it can continue to deliver a positive return even when the value of other assets is falling.
But it has a hidden, dark side, in that it does not protect investors from the erosive power of inflation over the longer term.
A carefully constructed portfolio of other assets, such as equities, bonds and commercial property, is more likely to deliver your long-term financial goals.
Inflation is a risk that all investors must have in their sights and it is not an easy one to mitigate in the short-term.
Over the longer-term, equity assets can help to deliver inflation-plus returns to protect and grow wealth.
The key is to mitigate this risk as far a possible by owning, and sticking with, a well-diversified investment portfolio.
Cash may have a role to play in everyone’s overall portfolio of assets. It offers essential liquidity to cover short-term expenses and can provide a buffer for unanticipated life events and emergencies.
If investors are tempted by the relative security of cash, they would do well to remember that there is no market timing bell and there is no knowing what markets will do next. Trying to second-guess the market is a challenging sport with few winners.
Samuel Kirton (right) is a financial planner with Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS