Logo Text

The Real Cost of Cash

September 2013

by Philip Dales   –  (Dales Independent Financial Advisers)

Why do we use cash so much for our investments, I think the main reasons centre on the fact that it’s a safe investment.

But that’s not entirely the full picture….

Inflation is eating away at your savings or cash investments every single day, inflation can wipe out its value just because its sitting in a bank account.

Why: The Technical bit

The Consumer Prices Index (CPI) is 2.9% the very best Fixed rate Cash ISA is 2.75% (Virgin Money 2.75% for five years fixed). Even with the best Cash ISA you’re losing 0.15% each year. It gets worse if your money isn’t in ISA’s as you’ll pay tax on the interest. The best non ISA savings bond is 3.5% (Skipton 3.5% fixed 7 years) take off tax (20%) you’re down to 2.8%, then inflation and you are down to a loss of 0.1%.

All the above assumes you are using CPI index not the more well known RPI which is higher at 3.3%, use this and the figures look somewhat worse, add in that you could be a higher rate tax payer and the loss per year is quite startling.

From 2002 to 2012 the total rate of inflation has been 37.80%, between 1992 & 2002 its been 27.22% and between 1982 and 1992, 70.74%.

If you invested £50,000 in tax-free cash savings in 2002 and spent the interest (a common situation for older people who need to top up their pensions) in 2012 you would have a sum worth £34,011 in real terms. Interestingly the average interest rates over the same period (source-Association of Building Society’s) is 3.91% so taking into account inflation & interest you would have a miserable £650 extra in real terms, if you hadn’t spent the interest.

Therefore are Cash Investments – Cash ISA’s. SAFE?

Not against inflation that’s for sure, this demonstrates that we should not use CASH for long-term investments. Short-term cash is ok; foregoing growth or income because we intend to spend the money. But, for longer-term, losing money each year against the costs of those items that you intend to buy seems a little foolhardy to me.

What about for those topping up pension income? There are two major problems facing people at present, inflation we have already discussed, ignore inflation the interest rates themselves are insufficient to maintain the income requirement for most and their lump sum is being eaten away in real and actual terms. The current rates of return on cash investments are simply insufficient.

So is there a solution?

Yes: The facts are longer term investments, such as fixed interests, bonds, gilts and equities and there are more such as property, art, fine wine, cars and antiques, which usually outperform cash. What’s the price of a better return? RISK. I have always felt that it is a simple truism of life: That the more risk one takes, the higher the potential for rewards, but like Newton’s 3rd Law. With the higher potential for reward comes the higher potential for loss. So like many other things in life, Investment Risk is a balance.

Look at these examples:

A house purchased at £50,000 in 2002 would have been valued at £85,000 in 2012 – above inflation growth and it appears a fairly low risk investment. Bricks and Mortar investments & Buy to lets are increasingly common, but there are more risks associated with property than many realize – we can offer buy to let advance and help in setting up your investment portfolio, letting you understand the risks  (Source Nationwide house price index).

A Medium/ cautious risk fund such as the Invesco Perpetual Monthly Income Plus – £50,000 invested in 2002 would now be worth around £120,990. This is the gross amount, but there are many straightforward ways to minimise the affect of tax on your investments, ISA’s for example are not limited to just over £5000 per year currently in equity ISA’s you can invest £12,520. Add this to a capital gains tax allowance each year and there is every chance that the impact of tax would be significantly less than a straightforward savings account. This fund mainly invests in Gilts, fixed interests and bonds with currently 20% invested in equities, the fund is available in a number of formats such as ISA’s and through many platforms. (Source – Morningstar Fund Data)

A Higher risk fund (keeping with the same brand) is the Invesco Perpetual High Income fund managed by the very highly regarded Neil Woodford. If you had invested £50,000 in this fund 10 years ago, this would now be worth – £168,475. With regard to tax and availability the same is true about this fund as above. (Source – Morningstar Fund Data)

I have not taken inflation into account with the above examples of the house, and the two funds for the simple reason that there is no need its fairly clear that the effects of inflation will have some impact, but all three examples out perform either the CPI or the RPI, and therefore you would have kept your money or increased it.

Conclusions – Moderation in all things.

Is cash “A bit rubbish really” well yes it is if your investing for the long term, don’t have any specific goals in mind or just need an income, but cash investments do have a role to play within any portfolio of investments. They give us a safety buffer, they are a safe place for money that’s going to be needed, but for anything else investments of a different type are necessary, investment advice is really worth seeking out to see how you can reduce the impact of inflation on your savings and investments.

Philip Dales Dip PFS Certs CII (MP&ER)
Director

For more information or advice on Investments contact Philip Dales at DALES Independent Financial Advisers: advice@pndales.co.uk or go to our web site www.pndales.co.uk or call our West Bridgford office: 0115 832 0265 or Newark Office: 01636 870 069.

Important information

The investment returns and any income can fluctuate, and investors may not get back the full amount invested. Past performance is not a guide to future returns. Where Philip Dales has expressed views and opinions these may change and do not constitute a recommendation. For individually tailored advice please contact either our West Bridgford (Nottingham) office 0115 832 0265 or our Newark office on 01636 870 069

Sources: All CPI and RPI data – Office of National Statistics, Fund information – Morningstar, Savings & ISA rates– Moneyfacts. Historical Average Savings rates – Association of Building Societies. House price growth – Nationwide Building Society’s House price Index.

P N DALES LTD are regulated by the Financial Conduct Authority: 496107.

Previous post: