Cash or shares? What the data tells us about where to invest

As higher savings rates compete with yields on many shares, Sam Benstead looks at whether cash or the stock market is the best home for your money.

With interest rates rocketing from just 0.1% to 5% in 18 months, saving rates have also soared.

Investors can get about 5% from savings accounts, if they shop around and are willing to lock up their money for a year or more. Easy-access cash ISAs pay about 4%.

These returns appear very attractive given the security of having your money in cash, protected from market gyrations, especially when compared with the very low rates savers earned before interest rates moved up.

However, cash is not the risk-free option that many assume because of the corrosive effects of inflation on returns.

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Schroders, the fund manager, calculates that cash returns after inflation – or “real” returns – remain negative, even though rates have risen strongly. Inflation is at 8.7% in the UK, well ahead of the 5% on offer from cash.

Duncan Lamont, head of strategic research, says: “Negative real returns mean losses. And the jump in inflation since early 2022 means that the value of cash is now eroding at a faster pace than for most of the previous decade, even if the cash earns today’s top available rates.”

Lamont argues that the stock market is a better place for long-term savings. “Over short periods cash is likely to fare better against inflation. Over long periods, cash fares worse, even where inflation is relatively low,” he said.

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It found that over very short periods – three months or less – there has not been much difference in the likelihood of cash or shares, as measured by an index of US large-cap stocks, beating inflation. But for longer periods the gap widens “conclusively”.

The likelihood of stock market investments beating inflation is 100% where the investments are held for 20 years, according to Schroders.

“In other words, for every 20-year time frame in the past 96 years, equities delivered inflation-beating returns.

“So while stock market investments may be risky in the short run, when viewed against inflation they have offered far more certainty in the long run,” Lamont said.

The research concludes that while cash does have a place in portfolios, over the longer term the stock market has been the best place to be invested, even though in approximately half of the past 50 years the MSCI World index fell by at least 10%, and in a quarter of the past 50 years it fell by at least 20%.

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What to invest in

Schroders calculates that US smaller companies delivered the best returns ahead of inflation since 1926, followed by American large companies and then long-term government bonds. Its data on cash versus stock market returns was based on the performance of large US shares.

Credit Suisse figures show that since 1900, US shares have returned 6.4% above the inflation rate and UK shares have returned 5.3%.

Investors looking to track the performance of US shares could buy the Super 60-ratedVanguard US Equity Index, which costs just 0.1% in fees. Global shares can be accessed for just 0.2% via the Super 60-ratediShares Core MSCI World ETF, and UK shares via the Super 60-ratedFidelity UK Index.

Cash-like investments also offer good alternatives to savings accounts. One option is to look at money market funds, which own a basket of bonds set to mature soon, meaning their prices are not very volatile but the yields are generally greater than those offered by bank accounts.

A popular option among interactive investor customers is the Royal London Short Term Money Market fund. Costing 0.1%, it currently yields around 4.5%, but the income will rise as higher-yielding bonds are added to the portfolio.

In contrast to fixed-term savings accounts, the yield from money market funds will rise and fall as interest rates do.

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Buying gilts directly is another cash-like investment option. Customers of interactive investor are buying up gilts set to mature in the next couple of years, with bonds maturing in 2024, 2025, and 2023 as the three most-popular choices. This suggests investors are holding the gilts to maturity, locking in yields of more than 5%.

Given that UNITED KINGDOM 0.125 31/01/2024 (LSE:TN24), UNITED KINGDOM 0.25 31/01/2025 (LSE:TN25), and UNITED KINGDOM 0.75 22/07/2023 (LSE:TG23) are low coupon bonds trading below par, most of the returns will come when the gilt pays back its £100 principle on maturity. This capital gain is tax free, making these gilts especially attractive for investors who have used up their ISA allowance. In addition, cuts to the tax-free capital gains allowance are making gilts an even more effective way of reducing tax bills.

Investing in fixed income directly requires careful research, but buying a bond fund requires less expertise.

High-yielding Super 60 bond funds include Royal London Sterling Extra Yield (6.7% yield); Royal London Global Bond Opportunities (5.9%) and M&G Emerging Markets Bond (5.6%).

Bond funds are sensitive to changes in interest rates, with higher than expected rates likely to trigger a sell-off, and lower than expected rates generally good news for bond prices.

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Another option designed to preserve wealth, unlike cash which sees its valued eroded by inflation, is a multi-asset fund. Such funds are diversified across stocks and bonds, as well as other alternatives such as commodities or property.

Anthony Rayner, multi-asset fund manager at Premier Miton, said: “We don’t see cash as lower risk than a low-risk multi asset portfolio, principally because cash doesn’t consistently outperform other key assets, plus holding just cash doesn’t provide diversification. 

“Instead, actively managing a range of multi assets, potentially including some cash, with an open mind and a willingness to be nimble, seems a more sensible way to go about wealth preservation over the longer term.”

Rayner runs the Premier Miton Cautious Multi Asstet fund. It owns a mix of bonds and shares, as well as gold.

Multi-assets funds on the interactive investor Super 60 investment ideas list include Artemis Monthly Distribution, Fidelity Multi Asset Income and three of the funds from Vanguard’s LifeStrategy range: the 20%, 60% and 80% versions.