Are you holding too much in cash?

Martin Banerjee

Chartered Financial Planner, Glasgow

In response to surging inflation, the Bank of England took aggressive measures, hiking interest rates from 0.1% at the end of 2021 to a peak of 5.25% by August 2023. This meant cash deposits became more attractive with higher interest rates, something we haven’t seen for a very long while.

The impact on markets

In 2022, rising interest rates combined with higher inflation impacted equity and fixed income markets, which endured a difficult period. Whilst this was a volatile calendar year, it is worth highlighting that markets can see short term periods of sharp falls as well as rises and can be caused by a wide range of factors – in this case rising interest rates and high inflation, with the latter impacted by events such as the war in Ukraine. Although market volatility can be unsettling, every long-term investor will experience it from time to time, therefore looking at short term market performance may not be an accurate reflection of underlying values.

The uncertainty seen in 2022 in particular, combined with rising interest rates, saw many investors withdraw from markets or refrain from investing as they sought cash-like investments. However, whilst the return from cash has improved, it’s worth noting that initially it still failed to beat inflation until prices recently fell.  It is also likely we will start to see the Bank of England reducing interest rates in the second half of this year.

Cash and falling interest rates

As interest rates start to fall, this will reduce the return on cash where the rate is variable, whereas if the monies are in fixed term accounts, it could mean only a lower return is available at maturity. There is also the risk of missed opportunities from investing in markets, which was highlighted in 2023 by the much stronger performance from investments following the difficult 2022, whilst this year has so far seen further gains from equities.

Historically, investing has outperformed cash over longer periods, even with occasional volatility. It is crucial to take a long-term perspective during difficult periods when markets are suffering losses and to not act too quickly. By selling investments too early, this will likely mean missing out on any recovery. Historic data suggests that while most investments may face some short-term volatility, they generally trend upwards over the longer term – although this cannot be guaranteed over all timeframes.

Importance of ‘time in the market’

The accompanying graph highlights the performance over the past 10 years of the UK base rate, inflation (measured by the Consumer Price Index) and the average performance of the IA Mixed Investment 20-60% Shares and 40-85% Shares sectors – these have been used as they offer exposure to a spread of investments across different asset classes such as equities and fixed income, as well as regions and sectors.

Whilst the performance of the investment sector averages is more volatile than cash, it does also show stronger long-term performance. In comparison the UK base rate has failed to beat inflation over this period.

Our view

We would always advocate holding sufficient short-term ‘ready’ or ‘emergency cash’ balances, as this will provide a secure home for these monies should they be needed, particularly in the event of unexpected emergencies.

However, over the longer-term, it should be considered whether cash is the right place even during the current period of higher interest rates. We would still expect inflation over time to reduce the buying power of cash-based investments, as shown in the graph. Instead, providing some risk can be accepted and periods of short-term volatility understood, we believe that over the medium to longer-term (at least five years), investment in multi-asset fund(s) can potentially offer better returns.


CA12211 Exp 06/25.

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