The false promise of cash

The False Promise of Cash

Until quite recently putting your savings into a bank account was effectively the same thing as sticking it under the mattress; a riskless proposition to the extent that you’d receive the same amount back, at least in nominal terms. Unfortunately, you were earning almost no return irrespective of what you had decided to do with the cash. Interest rates were effectively zero and there was virtually no inflation. However, the environment is quite different now and a cursory Google search reveals that there are superficially quite good interest rates being offered to depositors from the high street banks and several less well-known institutions. Unsurprisingly, we are often asked whether in this new environment, investors should a) allocate more/all of their wealth to cash, b) use cash as a timing tool because there is less opportunity cost to holding cash as interest rates have risen or c) employ some combination of both.  

Is the cash in your bank account totally safe

Cash sitting in a bank account is not completely without risk. The UK does have a deposit guarantee scheme, but it is capped, so if one’s bank finds itself in dire straits then there is a chance that amounts of above the threshold would be lost. In practice the government would probably bail depositors out. In the meantime, it would be a very stressful period for anyone with their money in a failing bank. Depositors are entitled to have accounts at several different banks to mitigate this risk and this is an entirely sensible strategy, albeit not without its own complications. Contrast this arrangement with a portfolio held in a nominee company where the investment manager has no claim over the assets in question whatsoever. They are in financial industry speak, ringfenced. 

After inflation returns are critical

What about the other three options? In an inflationary environment, which we are now in, it is important to draw a distinction between ‘nominal’ and ‘real’ interest rates. If a bank is offering you 5% interest on deposit and inflation is 6% for example, your real return is -1%. Mathematically the real or actual return you receive is the quoted (nominal) rate less inflation. Investors saving for retirement, a child’s education or to provide an inheritance should care only about real returns.  There is after all a price to be paid for the relative security of a bank deposit. Banks are businesses that specialise in paying depositors less interest than they earn from the loans they have made. This is called the net interest margin.  In comparison, the investments that one would find in a well-constructed portfolio are going to have a degree of inflation protection, in addition to the ability to pay an income and grow the underlying capital value. This is precisely why over almost all periods a portfolio of investments containing a significant exposure to stocks tends to outperform. In summary, cash ought to be a short-term safety net for unexpected expenses only. The precise quantum of which will depend on the personal circumstances of the individual in question. 

Missing the big up days

What about using cash as a timing tool. The standard response to this suggestion would be to paraphrase the old market adage that it is ‘time in the market, rather than timing the market’ that matters. Academic studies and real-world experience confirm this statement to be broadly true. Over time global stock markets tend to rise as societies progress and grow richer.  On any particular day however the odds that the market is going to be up is only slightly better than a coin toss weighted in an investor’s favour. Furthermore, the actual percentage change either up or down on a specific day tends to be within a fairly tight range, crucially though there is a proportion of days where the market moves in a positive direction by a significant amount. It is these days that really make a difference to the total return an investor will earn and missing a few of them matters. In summary stay invested because the coin itself is loaded in your favour and there are going to be some big positive days that you do not want to miss. Cash cannot offer the same attractive terms.     

We do not profess to know for certain when these big ‘up-days’ are likely to be. Experience has taught us that they often occur when investors have systematically misunderstood the outlook and are too cautiously positioned. The prevailing wisdom at the beginning of 2023 was that a US recession was imminent. This has proved to be wrong, and the world’s largest economy has continued to expand in spite of the headwind of much higher interest rates. Inflation appears to be subsiding, the banking trouble seems to be behind us, the debt ceiling was raised, and the labour market remains strong. We also think that investors as a group, whilst not nearly as pessimistic as last year, are still largely sitting on the fence. We are in a ‘show me’ market that will probably grind higher. Notwithstanding this, we are concerned that the prices of some of the stocks associated with the excitement surrounding AI have become untethered from reality. Nvidia is the most notable example, and consequently we have been taking profits. Competition is likely to become fierce in the hardware supporting this technological advance, where they are the leader, so we are monitoring developments here carefully. 

The economic situation in the UK is more difficult and unfortunately inflation is proving much stickier here than elsewhere. The reasons for this are fairly specific to the post-Brexit landscape and the Bank of England has not helped matters, just as they were too late to begin tightening, we suspect they are going to ignore early evidence of disinflation and inflict needless pain on the economy. 

Disclaimer: This communication is issued and approved by Whitman Asset Management Limited (“Whitman”) which is Authorised and Regulated by the Financial Conduct Authority. The value of investments may fall as well as rise and your capital is at risk. The information does not constitute financial advice or recommendation and should not be considered as such. Conduct your own research and seek independent financial advice when required.

Although Whitman uses all reasonable skill and care in compiling this report, no warranty is given as to its accuracy or completeness. The opinions expressed accurately reflect the views of Whitman at the date of this document based on our views at such time regarding market conditions and other factors, may depend upon assumptions or projections that may not prove to be correct, and are subject to change. The opinions stated are honestly held, they are not guarant

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