Log inWhy should you remain invested when you can get 5% in a cash deposit account? – 30th October 2023 from Jon Telford
It is now possible to earn interest rates of 5% on cash deposits in the UK if you know where to look. For example, Telford Mann’s Money Market Account service (an alternative to cash deposit accounts) is currently paying an implied rate of return of 5.51% per annum.
With cash returns at this level at the moment, some clients are sensibly asking why they should remain invested.
Three reasons stand out:
1. What you can get now compared to what you will get in a few months’ time.
This is the big one. You might be able to get 5% on cash right now, but what will you be able to get in a year’s time? Or five years’ time? Putting your money in cash means you are exposed to what central banks do to interest rates in the future, sometimes described as “reinvestment risk”, and short-term interest rates are not expected to stay at current levels for much longer, even if they’re unlikely to fall back to the ultra-low levels we have seen in recent years.
For example, the Bank of England expects that interest rates will fall to 3% over the next year or so and they could fall lower if the UK goes into recession, as many are predicting. That’s a lot less than the current 5.25% rate.
In comparison, Telford Mann portfolios are heavily invested in government bonds (gilts) and other Fixed Interest holdings which are also yielding 5% per annum, but the difference between the portfolios and a cash deposit account is that the portfolios will be paying 5% per annum for the next 10 to 15 years or so.
2. Recession risk
If things get ugly on the economic front, the Bank of England is likely to cut interest rates to stimulate demand. If this happens, interest rates on cash deposits will quickly follow them lower.
This will also likely lead to lower bond yields as the market starts to price in those rate cuts. Government bond prices and values will therefore rise.
Cash returns down, bond returns up has been the historical playbook in this scenario. Even if central banks don’t cut rates, e.g., if they remain concerned about inflation, safe-haven buying could send government bond values higher.
“I hear you” you might be thinking “but I’m happy in cash right now. I’ll invest in bonds when cash rates fall back”. Unfortunately, it doesn’t work like that. Markets are forward looking and by the time that central banks are cutting rates by much, bond yields will probably also be lower than they are today. A “wait and see” approach could lead to missed opportunities.
Many investors have been drawn in by the simplistic appeal of high interest rates on cash deposits. But this is unfortunately a short-term view of investing.
3. The Economic Cycle
The third and final reason you should remain invested is, in my opinion, the most compelling. Economies move in cycles of expansion and recession and being invested in the right assets when the cycles change is vital.
There is no doubt that the return from investment portfolios over the last couple of years has been poor and so, in the face of seemingly never-ending declines, it is not unreasonable for investors to question why they should remain invested.
However, history tells us that a period of decline will be followed by a period of significant growth.
This can be demonstrated by looking at how the Telford Mann client portfolios performed during the 4 economic crises we have seen during the last 17 years.
Global Financial Crisis – 29/10/2007 to 28/04/2010
The chart above shows the decline before and the subsequent rise after the Global Financial Crisis. In the 12 months prior to the lowest point of the cycle, our portfolios were down by 23%. However, during the following 18 months, they bounced back by 53.67%. After taking into account the previous losses, the total return for the Telford Mann portfolios over the period was 19.19%.
Eurozone Crisis – 08/07/2011 to 04/04/2013
In the 3 months prior to October 2011, portfolios dropped by 16.33%, but in the next 18 months to April 2013, they bounced back by 27.18% and so the total return of the period was 6.23%.
Brexit Crisis – 13/04/2015 to 11/08/2017
In the 12 months prior to the Spring of 2016, concerns over Brexit meant that portfolios dropped by 15.9%. However, in the following 18 months the Telford Mann portfolios gained 31.19% meaning an overall return over the period of 10.31%.
Covid Crisis – 17/01/2020 to 23/09/2021
As it became clear in early 2020 that Covid was a big problem for the world, portfolios dropped by 19.84% between January and March 2020. However, from the March 23rd low point, the Telford Mann portfolios returned 49.97% in the next 18 months, providing an overall return of 22.96% over the period.
Summary
Hopefully this provides some reassurance as to why it pays to stick with investing, even when we see protracted periods of declines.
As the saying goes, it is always darkest just before the dawn, but hopefully dawn is not too far away.