Why equities are still better than cash

There’s been good news and bad for savers in recent weeks. The positive is that interest rates on many bank and building society accounts are on the rise. You can now get 2.5% on some easy access accounts – the highest level for a decade – and even more if you agree to lock your money away for longer*.

However, these increases come at a time when the rate of inflation has already soared to 10.1% and is expected to hit 11% before the end of the year.

So, where does that leave investors? Should they take advantage of better rates on their cash for the next few months or are they still better off investing?

What’s happening to savings rates?

Interest rates on variable cash accounts have been rising due to fierce competition and consecutive base rate rises by the Bank of England, which is fighting to contain rampant inflation.

However, not everyone has been passing on these hikes so it’s important for people to shop around, according to Rachel Springall, spokesperson for Moneyfacts. “Challenger banks and building societies currently offer some of the best rates across easy access, notice and equivalent ISAs, but the terms and conditions can vary considerably,” she said.

The average rate on fixed bonds, meanwhile, is around 3%, according to Moneyfacts data, while various top rate deals are paying above 4%. 

“There may well be savers out there who may sit and wait for even higher returns, but as with any deal, they are not guaranteed to last forever,” she added.

How does this affect you?

The fact remains that with inflation so high, even with the enhanced cash rates on offer from many banks and building societies, your money is still losing value in real terms.

Does that mean savings accounts should be ignored? Well, no. These accounts are important as they enable you to set money aside – particularly money you may need in the short term - and have it earning at least some interest. For example, you should always have money in an easy access cash account to cover emergencies, whether that’s the boiler packing up or getting your car through its MOT.

With all the volatility in equity and bond markets it would also be easy to conclude that cash would be the way to go now and forget about investing. But that could be a mistake.

Why you should still invest

Investing is, without a doubt, riskier than saving into cash. The value of an investment made in an individual asset or fund may rise sharply or fall dramatically, depending on a number of factors.

But, as Kevin Murphy, co-manager of Schroder Income fund, explained recently, investing offers the prospect of significantly higher rates of return than you’d get from tucking your money away in the average savings account.
 
“Let’s say you invest £100 in your building society account earning 4%, you’ll gain £4 a year interest,” he said. “Stocks today yield just less than 3.5%. So, if you invest £100 in a stock, your dividend return will be £3.50, which is clearly less than the £4 interest.
 
“But when you invest in a share, you get something that you can’t get when you put money into a bank account, and that’s the potential of capital growth. 
 
“To give you a real-life example, when the Schroder Income fund was launched in 1988, it’s yield was about 3.5% and, 34 years later, its yield is still about 3.5%. But because of the growth in capital, it’s 3.5% of a very much larger number.

“So, if you invested £100 at the dawn of the fund, your dividend would’ve been £3.50 a year, but because of the growth in the capital part, that £100 invested will now be delivering £18 worth of dividends each year because the £100 has grown and the income has grown alongside it. And that’s something that simply can’t happen for money on deposit.”

A balanced portfolio may pay over time

Chelsea’s own James Yardley has also pointed out that a mixed balanced portfolio of 60% equities 40% bonds has beaten cash 73% of the time on a rolling five-year basis over the past 30 years**.

“Having looked at the data, the cumulative return of a balanced portfolio was 722% over 30 years compared to just 150% for cash**,” he said.

This period includes several stock market and bond market crashes including the tech bubble, global financial crisis and Covid.

“The best period for cash was during the dotcom bubble between 1997 and 2002 when it outperformed the balanced portfolio by 31%**,” he continued. “The best periods for the balanced portfolio were between 1992 and 1997, and 2011 and 2016 when it outperformed cash by 73% and 71% respectively**.

“Overall, you have been much better off being invested in the balanced portfolio versus cash over the longer term, as you would expect.”

Funds to consider

Investors looking to make the most of dividends and capital returns could consider equity income funds on the Chelsea Core Selection such as LF Montanaro UK Income, BlackRock Continental European Income or Fidelity Global Dividend. 

Bond funds are also looking more interesting now that yields have increased. Here, Rathbone Ethical Bond, Jupiter Strategic Bond and TwentyFour Dynamic Bond - which are also on the Chelsea Core Selection - are worth consideration.

Investors who prefer a multi-asset portfolio could of course also look at the VT Chelsea Managed Monthly Income fund, which invests in many different assets and has consistently produced an income of over 4% since launch***.

*Source: Moneyfacts, 3 November 2022
**Source: FE fundinfo, total returns in sterling, 30 September 1992 to 30 September 2022
***Source: Chelsea Financial Services, 3 November 2022

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund manager and do not constitute financial advice.