Cash VS Shares

The Emergence of an Interesting Revisionist Perspective

By Michael Dow

The old saying that 'cash is king' is not always taken seriously by investors. In this era of rock bottom interest rates on savings and rampant central bank money printing, which has highly undesirable effect of eating away at the value of paper money, nobody in their right mind wants to have tonnes of spare cash sitting around in bank accounts, or worse still, hidden under the mattress for a rainy day. Instead the seemingly most logical thing to do is put the capital to work by investing in stocks, bonds, real estate, commodities or some other kind of asset that will hopefully produce a healthy combination of capital appreciation and dividend income. Even though these asset classes have arguably also been less secure and more volatile in the short term over the last few years than in times gone by, there is plenty of evidence to suggest that in the long run it is far better to put your cash to work rather than leave it to gather dust or measly rates of interest from the bank every year.

However, if the findings of a new study by BBC journalist and respected financial analyst Paul Lewis are to be believed, there might be a much stronger case to be made for cash than what many of us previously overlooked. The high profile financial journalist has carried out a huge study which challenges the conventional wisdom that investing in stocks is more rewarding than saving if you stick with it over the long term. The ground breaking new research, which covers the period from 1995 to the present day, assumes savers are savvy enough to find the best buy account and move their money into it every year. In accumulating the data Lewis compared returns from the top one-year deposit account each year since 1995 to the money made on a simple tracker fund cloning the performance of the top 100 shares listed on the London stock market. This 'active cash' beat the tracker in 57 per cent of 192 rolling five-year periods from 1st January 1995 onward. And cash did even better over longer periods, beating the tracker fund 96 per cent of the time in the 84 rolling 14-year periods since 1995.

Lewis also highlighted that the tracker fund lost money up to a third of the time over investment periods ranging from one to 11 years - whereas cash savings will always grow. The research took into account dividends reinvested in tracker and any interest earned reinvested in cash savings, so gains from compounding were included in both cases. Over the whole period shares did win out but by a small margin that is small enough for savers to question whether the risk was worth it. Moreover, Lewis argues that money invested in best buy cash over the whole 21-year period from 1st January 1995 to 1st January 2016 would have produced an average annual compound return of 5 per cent, while the tracker would have produced a compound annual return of 6 per cent. The 1 per cent difference is far lower than the 3-8 per cent typically quoted as the 'risk premium' of investing in shares rather than cash.

There are of course some other benefits of keeping cash in a relatively easily accessible bank account rather than using it to buy shares or other less liquid assets. If a golden opportunity comes along that requires large amounts of capital investment but your cash is tied up in stocks that are relatively down in price or bonds that are not liquid it is simply a case of missing out on a potentially lucrative venture. Then there is obviously the fact that so called 'rainy days' do often come around when we least expect them, and having cash on hand is definitely preferable to having it tied up.

While these new findings are definitely worth considering, it has to be conceded that there are a still some very compelling reasons to favour stocks, bonds and other, more active investment strategies. Since the study was brought to light, a number of high profile money managers and financial commentators have come to the defence of shares. "A balanced savings approach encompasses both cash and shares in order to maximise returns while providing some ballast" says Laith Khalaf of DIY investment broker Hargreaves Lansdown. Savers who are very risk averse, or who may need their money in less than five years' time, should stick with cash, as over shorter periods the chance of losing money on the stock market is higher. "However, with cash rates on the floor and showing little sign of perking up, it is only prudent for investors to consider putting their long-term money into the stock market. This is particularly the case given that charges on tracker funds have been cut to the bone, thanks to the passive price war that has been raging for the last few years." Khalaf also notes that active funds, where a manager tries to outdo the market, are also available to investors. "On average these have comfortably beaten the FTSE 100, and some have wiped the floor with it" he says.

Other analysts have pointed out that while Lewis raises some interesting questions about the value of cash versus index trackers there are some important methodological concerns that need to be addressed before investors start keeping more of their hard earned savings into bank accounts. Patrick Connolly, of financial services firm Chase de Vere, says: "The research produced by Paul Lewis makes interesting reading and should at the very least be 'food for thought' for many investors. Some of the assumptions he makes are not practical, such as being able to instantly access the best paying savings account each year and for non-Isa cash savings not being liable to tax on interest (in the past). However, his numbers still have some merit. It is an easy counter-argument to say that many active funds outperform the FTSE 100 index. However, the reality is that many active funds also under-perform and many investors make wrong decisions, such as jumping into shares near the top of the market".

What's more, Connolly reckons that where Lewis is wrong is that the research assumes the investment option is being fully invested in FTSE 100. It is true that many people who are not taking advice won't have enough diversification in their portfolios and are likely to be taking too much risk. "However, Paul is absolutely wrong when, referring to the likelihood of the FTSE-100 falling, he says that "few advisers know these odds, still less inform their clients of them".

Summing up, there is definitely a good case to be made for keeping a significant amount of your net worth in cash. Safety is extremely important, as is the ability to take advantage of new opportunities when they arise. However, there is also an array of very compelling evidence to suggest that even if one takes more cautious route of parking money in index funds, as opposed to actively managed mutual funds and the like, returns on investment over the long term are phenomenal – especially when compound dividends are factored in. So hang on to your cash, but not all of it.

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