Cash rates are rising, but lag inflation: here’s where to invest instead

Higher savings rates in response to rate rises look appealing, but over the long term it is investing that offers the great potential to outpace inflation. For those considering investing for the first time, Faith Glasgow considers the best options for growth investors and income investors looking for a one-stop shop fund solution.

As the Bank of England continues to hike interest rates to try and reduce inflation, cash savings accounts are finally worth keeping an eye on again, with the best-paying instant access accounts offering 4.6%.  

But while that may sound an awful lot better than the rock-bottom rates of recent years, it’s nowhere near a match for inflation, currently running at 7.9%, and is proving a real headache for the Bank of England to control.

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Over the long term, therefore, it still makes more sense to invest your money in the stock market, despite its ups and downs. As the 2023 Barclays Equity Gilt study points out: “The long-term case for investing in risk-assets is strong, in particular when considering longer investment horizons”.

The study, which looks at the performance of UK equities against UK government bonds and cash from 1899 to 2022, finds that over any two-year period the probability of equities outperforming cash is 69%. Over a 10-year period, this rises to 91%.

There are no guarantees, of course, but such numbers offer powerful food for thought for long-term investors.

How to make the first step up from cash

So, if you are a relatively cautious and are considering making the switch from cash to investing, where should you start?

Collective investments in the shape of funds, investment trusts and exchange-traded funds (ETFs) are an obvious first port of call in preference to individual equities, because they spread investment risk across a ready-made ‘basket’ of shares (and in some cases also other types of asset such as corporate and government bonds).

However, these stock-market investments are inherently more prone to short-term fluctuations than other asset types. That makes them a relatively risky proposition, especially if you’re only investing for a few years and your money might not have time to recover from a market setback.

Everything else being equal, the longer your time frame, the more you can afford to hold in equities. If you’re in your 30s and building a pension for 30 years’ time, for instance, it makes sense to focus largely or exclusively on equity funds.

If you’ll need the money a few years’ time or you don’t feel comfortable taking much risk, it’s possible to dial down the risk by reducing the proportion of equity exposure you hold relative to bonds, cash, property and/or other less volatile holdings.

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The big difficulty for starting investors is that the collectives universe is an enormous and daunting marketplace. The most straightforward solutions are therefore arguably ‘one-stop shops’ that do away with the stress of identifying a portfolio of funds that will suit your needs.

However, Gavin Haynes, investment consultant at Fairview Investing, sounds a note of caution in regard to the one-stop approach. He says: “Even if you have only a modest amount to invest, I think splitting monies across more than one provider makes sense under the ‘not having all eggs in one basket’ rule.”

Against that, one-stop shops provide a simple, easily accessed solution. As Justin Modray, who runs Candid Financial Advice, explains: “The key, when choosing one-stop investment options, is to ensure a decent spread of investments that are appropriate for the amount of risk you are comfortable taking.”

These investments are typically multi-asset funds that incorporate a mix of equities and bonds, but in some cases also other assets such as private equity, gold, infrastructure, and property.  

Often they are ‘funds of funds’, whereby the portfolio manager selects and monitors in-house or external funds rather than buying shares or bonds themselves.  

Passive multi-asset funds a good place to start

Some may be low-cost options that invest in tracker funds, aiming simply to follow the fortunes of the market itself. Others use actively managed funds, with the portfolio manager adjusting the proportion allocated to different asset classes to reflect the macroeconomic environment.

If you like the idea of a passive, market-following approach that keeps costs to a minimum, the five Vanguard LifeStrategy range of multi-asset funds is an obvious starting point. Three of these funds appear on interactive investor’s Super 60 investment ideas list: 20%, 60% and 80% equity.

The five variants have an annual charge of just 0.22% a year and use a mix of Vanguard tracker funds to offer differing levels of global stock market exposure, from 20% to 100%, with the balance held in fixed interest trackers in each case.

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Haynes suggests LifeStrategy 60% Equity as a good option for a balanced investor willing to take a moderate amount of risk. “This aims to offer a simple, low-cost, balanced diversified portfolio in a single fund, with passive exposure to global bonds and equity. The choice of which index funds to use is based on the investment managers’ views,” he explains.

For more adventurous investors, Vanguard’s LifeStrategy 100% Equity provides cheap and well-diversified exposure to a wide range of index-tracking funds.

Modray is also a fan of the range. “I believe these funds are suitable for growth or income (the latter provided the platform can automatically sell units to provide regular monthly withdrawals),” he observes.

Actively managed fund of funds have pros and cons

If you’re keen to have greater active asset allocation and fund-picking input from a real portfolio manager, there are numerous options.

However, says Modray, actively managed funds of funds have both pros and cons. “The managers will automatically change the portfolio as required and ensure it remains balanced – but they often charge an extra annual fee for their service on top of annual fees for the funds held within.”

He is less keen on them because of that additional layer of fees, which can make a big difference to total returns over the long term. However, he says: “Popular options include Jupiter Merlin and abrdn MyFolio fund ranges.”

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Some one-stop solutions use a mix of individual investments alongside or rather than other funds to achieve a similar result without the issue of additional charges.

For cautious investors, Haynes highlights Newton Real Return as a conservatively managed multi-asset fund aiming to deliver cash plus 4% compound annual return over five years. “The portfolio’s split between growth and defensive assets will vary based on the manager’s view of the world, and they will employ highly active asset allocation,” he adds.

Wealth preservation trusts aim for a smooth ride

An interesting alternative is the TroyTrojan fund or Personal Assets (LSE:PNL) investment trust, both run in the same way by respected manager Sebastian Lyon, with a strong emphasis on protecting capital and keeping volatility low.

That’s achieved through careful asset allocation based on the manager’s top-down view, together with “a focus on valuations and careful selection of high-quality equities”, says Haynes.

He suggests another wealth preservation trust, Ruffer (LSE:RICA), as a possible choice for balanced investors.

Haynes says: “The twin objectives are to not lose money on a 12-month rolling basis, and to significantly beat cash returns over the medium term.

“The strategy has built up an impressive track record through active asset allocation, value stock selection and the use of protective strategies. I believe this fund can provide an excellent core defensive bedrock for a portfolio.”

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Income investors could consider Artemis Monthly Distribution fund, which uses a mix of bonds and global dividend stocks with a value style to generate an attractive level of income distribution plus long-term growth. This is one of interactive investor’s Super 60 investment ideas.

Generalist global investment trusts

For investors with a long time frame and the stomach for a riskier but potentially more rewarding broad equity fund, there’s strong candidates in the shape of highly diversified generalist global investment trusts such as Alliance Trust (LSE:ATST), Witan (LSE:WTAN) and F&C (LSE:FCIT). All use a multi-manager approach to provide expertise in particular markets.

Alternatively, if you’d prefer to hold a small portfolio of funds/trusts, rather than a single multi-manager choice, model portfolios such as those available on interactive investor comprise ideas for inspiration.  

The bottom line is that there’s plenty of choice for beginning DIY investors. But do think carefully about how long you want to invest for, how comfortable you are with the ups and downs of the stock market, how much involvement you want in managing the portfolio, and how important it is to you to have input from an active manager.