Why investing trumps cash over the long term

Improved cash savings rates haven’t escaped the attention of consumers. According to new data from investment house Janus Henderson, UK cash savings have leapt to £2.1 trillion this year, a £51 billion uptick from 2023 – a record high.

Elsewhere, the amount pumped into cash individual savings accounts (ISA) soared 34% in 2022-23, compared to the year before, to £41 billion.

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It's easy to see why savers and investors are beefing up their cash holdings. The top-paying accounts pay somewhere between 4.5% and 5%, and with year-on-year inflation registering 2.3% in October, you can outpace price rises without risking your capital.

But the gap between savings rates and inflation won’t last forever. In fact, it’s narrowed in the past couple of months after interest rates were cut twice and price rises accelerated.

The current climate aside, history tells us that over lengthy periods, the stock market offers a better chance than cash of growing your wealth.

Janus Henderson notes: “UK stocks have beaten cash in 22 of the last 30 years, while global equities have delivered better returns in 23 of these years. Even those who invested in a down year for equity markets would have beaten cash over the longer term.”

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As a 2023 study by Schroders found, “Over very long periods – during which inflation and interest rates have gone through both highs and lows – cash has retained its spending power, but only just.” In contrast, stock market investments delivered inflation-beating returns over all measured periods, according to the research.

But this message hasn’t reached the ears of all savers. Janus Henderson quizzed consumers about inflation, finding that more people believed cash accounts would protect the real value of their money over the long term (18%) than shares or funds (15%).

Cash vs shares in the past 25 years

Interactive investor’s own research strengthens the case for shares over the long term.

In the summer, we recently crunched some numbers to show the ISA pot you could’ve accrued if you’d maxed out your allowance every year between April 1999 and April 2024. Note: the results exclude investing fees.

Costs will have taken a bite out of these returns, but in any case, it illustrates how those who plumped for the stock market instead of cash over the past 25 years will have found their wealth in finer fettle – particularly those exposed to the S&P 500.

Admittedly, UK cash savings endured an extended rough patch following the 2008 global financial crisis. The Bank of England cut interest rates to historic lows, and they continued to crawl along the bottom until the cost-of-living crisis emerged in late-2021; an event that saw the bank rate hiked 14 times on the bounce to tame runaway inflation.

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Of course, the risk warning “past performance isn’t necessarily a guide to future returns” applies here and the outlook for cash savings is far rosier than it has been for some 15 years. But the Bank has started the rate-cutting cycle, with policymakers expecting to reduce interest rates four times next year. While we have no idea how things will pan out in 2025, it seems inevitable that interest rates will come down, making returns on cash savings less generous.

Which ISA types do people go for?

ISAs are often the first port of call when saving and investing for your future. Any growth, dividends and interest are tax free, meaning you get to keep more of the money you make.

Given how popular the tax wrapper has become, it’s always interesting to analyse which one(s) investors choose.

There are currently six ISA types in operation: Stocks and Shares, Cash, Innovative Finance, Lifetime, Junior, and Help to Buy (this one is no longer open to new subscribers).

But by far the two most popular versions are Stocks and Shares, and Cash, attracting almost £70 billion in the 2022-23 tax year. In response to higher interest rates, savers ploughed just over £41 billion into the Cash type, a sharp uptick from the £31 billion the year before. In contrast, the Stocks and Shares version saw subscriptions fall marginally over this period.

Both Stocks and Shares and Cash ISAs hold an important place in the savings and investing landscape. But selecting the right one is vital. Your investment time frame, attitude to investment risk and personal circumstances all play a key role in where you should put any surplus lump sums or income. As the Schroders study notes, if you’re prepared to invest for five years or more, the stocks and shares type has historically been shown to be a better horse to back.

However, you’re not restricted to choosing one or the other. You can invest up to £20,000 a year in ISAs, and this sum can be allocated across as many types and providers as you like.

You can also transfer between the two, which is handy if your goal has changed with that portion of your portfolio.

How much should you hold in cash?

This is a question that investors will ask themselves regularly. The truth is there’s no one-size-fits-all solution here.

Standard guidance is to keep at least three-to-six months expenditure in an easy-access savings account to provide a safety net to protect against emergencies such as a job loss, or significant unexpected expense.

In some cases, it’s wise to hold more than this figure. For example, if you’re self-employed the last thing you want is to place your businesses’ lifespan on shaky ground due to cash-flow problems.

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You may also want to avoid the stock market for any money you plan to spend in the next few years, for those in drawdown it can be sensible to keep a cash buffer of two-to-three years’ income to dip into should stock markets suffer a rough patch. Keeping some dry powder to capitalise on any stock buying opportunities can make sense, too.

For investors who want a short-term, low risk home to park some of their portfolio, money market funds could be a good option. They can offer a slightly higher return than cash savings and can be held inside ISAs and self-invested personal pensions (SIPPs).

Is lack of knowledge and experience an obstacle to savers?

Seasoned investors will be comfortable sticking any surplus cash in the stock market, but newer ones might be a bit nervy.

There are several myths about investing that may act as a deterrent. These include it being likened to gambling; you need a lot of money to start; and to succeed requires bundles of knowledge. None of these are true, but inexperienced investors aren’t to know this.

The unfortunate thing is that many who stick to cash ISAs might be better served with the stocks and shares type.

To support those who want or need help selecting suitable investments, because they lack either confidence or time, interactive investor have developed and launched the Managed ISA.

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So, how does it work? Well, once we’ve established you have a suitable investing time frame and any short-term debts are covered, we ask a few questions to establish your risk profile. interactive investor then matches you to the most suitable investment portfolio. After that it's over to the experts who manage your money on your behalf.

If your confidence and knowledge pick up over time and you feel savvy enough to select investments with a portion of your savings, you can do that within the same product. There’s no need to open two ISAs - one for managed investments and another for those you self-select.