The last decade has been difficult for savers. While ultra-low interest rates might have been a boon to mortgage holders and business borrowers, it’s been tough to find a cash savings account that pays a decent return.
Despite this, Brits are saving record amounts. This is Money report that during the height of the first lockdown between April and June 2020, households saved £54.6 billion, collectively adding another £17.6 billion last November.
However, while retreating to cash might give you comfort in turbulent times, and can be useful if you want to make a gift to loved ones who may need liquid assets, there are a range of reasons why you shouldn’t hold too much cash.
Other assets can provide greater long-term returns
Countless studies have shown that, over time, returns on assets such as equities outstrip those of cash.
The 2019 Barclays Equity Gilt Study compared the nominal performance of £100 invested in cash, bonds, and equities between 1899 and 2018. It found that:
- £100 invested in cash in 1899 was worth just over £20,000 in 2018
- £100 invested in gilts in 1899 was worth close to £42,000 in 2018
- £100 invested in equities in 1899 was worth around £2.7 million in 2018.
Of course, it’s unlikely you’ll be wanting to invest for more than a century! Even though your investment horizons may be shorter, the same Barclays survey suggests equities will still outperform cash.
They found that UK equities outperformed cash for two consecutive years in 81 of the 118 periods studied. So, while the probability of equities beating cash over two years in a row is 69%, extend the holding period to ten years and your chances of beating cash rise to 91%.
Savings rates will struggle to beat inflation
Recent research from Moneyfacts found that there were just three easy access savings accounts in the UK which paid a rate of interest that could match the inflation rate. This means that, if your money is in an instant access account, the chances are your returns are not keeping up with rises in the cost of living.
Some accounts pay even less. Indeed, National Savings & Investments made headlines at the end of last year when they cut the interest on their Investment Account and Income Bonds to just 0.01% – that’s only £10 interest for every £100,000 invested!
In the worst-case scenario, a move to negative interest rates in the UK could even see you having to pay a bank to hold your money. In 2019, Denmark’s Jyske Bank introduced an annual charge of 0.6% for customers who held balances over $1.1 million. 2019 also saw UBS start to charge its high-net-worth clients a fee for between 0.6% and 0.75% for cash savings of more than €500,000 (roughly £440,000).
Even if you manage to find a fixed-rate bond or similar limited access account that pays a higher rate, the chances are that it won’t keep up with inflation in the years ahead.
Of course, if the returns you get on your savings are lower than the inflation rate, your money is losing value in real terms. It’s another reason not to hold too much cash.
It may not be protected if a bank fails
The Financial Services Compensation Scheme (FSCS) offers protection to savers with cash in UK institutions. In the event of the failure of a bank or building society, the first £85,000 of your savings are protected.
If you hold significantly more cash than this in one institution – and remember that if you have money with multiple providers that are part of the same banking group, such as HSBC and First Direct, they are treated as one bank – your cash could be at risk if that institution fails.
Therefore, it pays to hold cash in a range of accounts at different banks and mutuals so that you can benefit from full FSCS protection.
Cash doesn’t pay dividends
2020 was a tough year for people investing for income. Dividends in the third quarter of 2020 were half that of the year before, and the lowest for a decade.
By June 2020, 48 FTSE 100 firms had announced a reduction in, or suspension of, payments to shareholders. Regulators even forced UK banks to stop dividend payments for a spell.
However, the outlook for income investors in 2021 is likely to be better, with AJ Bell predicting an 18% increase in FTSE 100 dividends this year.
If you need to generate income, holding cash is unlikely to help you meet your aims. As we mentioned above, NS&I Income Bonds currently pay 0.01%, so even with £1 million invested your income would only be £100 a year.
You’re trying to time the market
One reason for holding too much cash might be because you’re waiting for the right time to get back into the market. This is where you should be reminded of the old adage: “it’s about time in the markets, not timing the markets”.
Predicting the bottom and top of the markets is very difficult, even for seasoned investment professionals.
Here’s a recent example: On 12 March 2020, the Dow Jones experienced its biggest one-day fall since 1987. If you’d patted yourself on the back for being out of the market on that point, you’d probably also have missed out on the single biggest weekly Dow Jones rise since 1974, which happened in the week before Easter.
Looking over the longer term, Vanguard found that, if you invested £100,000 in the FTSE All-Share index in January 1986 and left it until the end of December 2016, your investment would have grown to just under £1.83 million.
Had you missed just the ten best trading days over that entire 30-year period, your returns would have been roughly halved, to just over £969,000.
This shows spending time invested in markets leads to success. If you react to markets by retreating to cash — even for a short time — you could miss out on potential long-term growth.