Why cash trumps shares if you want top returns

Many people with shares-based investments will have been feeling glum this week after Brexit jitters wiped tens of billions of pounds off the value of leading UK companies. But at least they can be happy in the knowledge that, over time, the stock market always does better than cash held in a savings account … doesn’t it?

This conventional wisdom was challenged this week after one of the UK’s leading financial commentators published research showing that money in best-buy savings accounts has beaten the stock market over most periods since 1995. What will surprise many people is that, when it came to putting your money away for longer than 10 years, cash was often the runaway winner.

Paul Lewis, the presenter of BBC Radio 4’s Money Box programme, compared returns from a simple index tracker fund that follows the FTSE 100 index with cash that is moved each year into a best-buy one-year savings bond.

His analysis involved 21 years’ worth of data, and his headline finding was that the savings account cash produced a higher return than the tracker in 57% of the 192 five-year investment periods beginning each month from 1 January 1995 to the present. To put it another way, cash beat shares in 109 of the 192 five-year periods analysed, while shares beat cash in 83 of the five-year periods.

When Lewis looked at people who had put their money away for 10 years rather than five, which some might say is more realistic for stock market-based investments such as unit trusts, it was a dead heat: cash was the winner in 50% of the 132 possible investment periods, while shares topped the other 50%.

You might have imagined that for investment periods of more than 10 years, shares would be the hands-down winner. However, Lewis’s surprising finding was that for periods ranging from 11-17 years, cash came out on top.

For example, when you look at the 84 possible 14-year investment periods from 1995, cash beat shares 96% of the time. Similarly, cash was the winner 94% of the time when 15-year investment periods were analysed.

However, for investment periods of 18, 19 and 20 years, shares trounced cash. Over the whole 21-year period the tracker outperformed cash in a savings account: £10,000 invested in a tracker on 1 January 1995 became £34,098 by December 2015 – a compound growth rate of 6% a year. Cash achieved nearly £6,000 less, finishing at £28,105 – a compound growth rate of 5%.

But, while you might be able to make more money investing in the stock market than by saving in a bank or building society account, it’s also much riskier. With cash you will never lose money, provided you stay within the Financial Services Compensation Scheme limit, which is currently £75,000 – but that doesn’t apply to stock market investments. Over the survey period January 1995 to January 2016, five-year investments begun on the first of each month in a FTSE 100 tracker ended the period lower than they started in 46 out of 192 periods. That’s almost a one in four chance of losing money, says Lewis, who published the research in his capacity as a freelance financial journalist.

His findings challenge the widely held view that shares outperform cash and many other investments over the longer term. Even official leaflets and websites tend to promote this idea – for example, the government’s Money Advice Service website states that “the stock market tends to do better than cash over time”.

Lewis says: “I have long suspected the merits of cash were underplayed by traditional research, which compares poor cash rates with often exaggerated gains on investments in shares.” He says cash is not right for everyone in all circumstances. “But for a cautious person investing for periods of up to 20 years, this indicates that well-managed, active cash beat a FTSE 100 tracker more often than not. And, unlike a shares investment, it can never lose anyone money.”

If you are the sort of risk-averse person who has in the past opted to forgo potentially higher returns offered by stocks in favour of boring but safe savings accounts, Lewis’s findings may leave you feeling vindicated. But there are caveats.

In his analysis, cash is represented by best-buy one-year savings bonds – a type of deposit account offered by most banks and building societies. Lewis assumes that on each anniversary of the investment the bond is cashed in and then reinvested in the current best-buy one-year bond. However, responding to his findings, investment firm Hargreaves Lansdown says that, while in theory we should all be continually moving our cash from best-buy to best-buy, “in practice this is difficult to achieve and requires an unrelenting drive and efficiency which few of us possess”.

Hargreaves Lansdown also points out that index tracker fund charges have come down significantly in recent years. It’s now possible to buy a tracker from a company such as Fidelity with an ongoing charge of as little as 0.06%.

The tracker fund used in Lewis’s analysis is a real one – HSBC’s FTSE 100 Index fund – and the gains or losses are after all charges, with dividends reinvested along the way. This fund was chosen because it was a “typical” tracker, ie not cheap and not expensive, and just the sort of fund that might have been picked by an unskilled investor in 1995 (unusually, 21 years’ worth of data was available for this fund, as it was launched in 1994). The fund’s current ongoing charge is 0.18%, though in the past it would have been higher.

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It’s also worth pointing out that savings rates have come down a lot since 1995. At the start of that year the Bank of England base rate was north of 6%, and it went above 7% for some of 1997-98, but it has been at 0.5% for more than seven years. Currently, the best rate you can get on a one-year fixed-rate savings bond is 1.8%, from the online-only German player Fidor Bank. Charter Savings Bank and RCI Bank are paying 1.66% and 1.65% respectively.

Meanwhile, some critics will say that the vast majority of investors’ money is held in active funds, and that some active fund managers have delivered market-beating returns. It’s also worth noting that Lewis’s results do not take account of inflation, while no deduction is made for tax on interest or dividends.

Nevertheless, the findings challenge the view that putting money in a savings account is the poor relation of investing in shares. Lewis says that, from one to 20 years, cash wins in 55.7% of 2,520 periods analysed, while shares win in 44.3%. “This research gives different results to every other study of shares v cash. They universally state that shares do better than cash over every long-term period,” he says.

Saving rates plummet

Cash might have often beaten shares in the past, but whether it will continue to do so looks questionable when savings rates continue to plummet from already low levels.

Financial data website Moneyfacts.co.uk this week declared the savings market “under siege,” with providers slashing their rates, even though the Bank of England base rate has been static at 0.5% since March 2009.

In May, the website recorded 18 savings rate rises and 156 cuts, with deals falling by as much as 2%. According to Moneyfacts, the average easy-access cash Isa rate has fallen by 0.11% in six months to just 0.98%, the first time on record it has fallen below 1%.

On 1 June, Nationwide became the latest big-name provider to cut rates on many of its accounts. Flexclusive Isa rates have been cut to 1.2%, the e-Isa rate chopped from 0.75% to 0.5%, and the e-Savings rate cut from 0.45% to 0.25%. However, Nationwide also upped the rates on a few accounts, including its Easy Access Isa and Instant Access Isa, both of which now pay 0.5% – up from 0.25% and an average of 0.37% respectively.

Also this week, Tesco Bank upped the rate on its Internet Saver easy access account, which now pays a variable 1.27%, including a 0.52% bonus for 12 months.