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Cash isn’t ‘king’ (even if it looks that way from time to time)

Context is everything. Without it you might believe anything – even that the world is flat.

Don’t believe me? Try this party trick (described in Steve Keen’s Debunking Economics[1]). Take a two-feet section of ground. The curvature of the earth at this point is minimal, “to all intents and purposes” it is level, as is the section right next to it. The angle between these two areas is “so small that it is effectively zero”. Extrapolating this out to its – completely illogical – conclusion you can ‘prove’ that the whole globe is, in fact, flat.

This story, intended as a criticism of how economists focus only on the larger whole and ignore the smaller details, also highlights what happens if you zero in on one detail without thinking about context.

Just like the stock market…

2022 was a year like any other

The war in Ukraine, soaring inflation, rising interest rates, and all asset classes down by the end of the year. Enough to make any investor a bit nervous at the time, and yet it’s what we expect. These kinds of events happen 20% of the time.

That doesn’t stop some clients from asking about whether they should switch to cash however, to sit things out for a year while markets stuttered. On the face of it, this might seem like a viable temporary solution. In the last 18 months, UK interest rates have shot to a 15-year high at 5.25%, pushing up cash savings rates to some of their best in years and making cash or cash-like investments like money-market funds seem more attractive.

There’s not much in terms of market behaviour I’ve not already seen in a 20-year career. That’s why I can confidently say, switching back and forth from cash is a dangerous gamble with your future.

Don’t miss out on potential growth

One client was concerned their portfolio hadn’t grown in the last 12 months. Their portfolio targets a 6% net return each year to reach their financial goals. A year of flat performance meant they were concerned.

But measuring only against that line highlights the wrong point. Even if the trajectory moves away from the magic 6% over certain periods, the portfolio has grown 49% since I first met them. Putting that money into cash now would mean buying the highs (so they’ve probably missed the best part of cash’s rise in value). Also, they miss out on potential growth in their current assets when the market starts to pick up.

As long as the growth potential is still there (which it is) the best advice is to stay put.

Cash vs investing – a closer look

Let’s look at the numbers in more detail.

Aswath Damodaran, a professor at New York University’s Stern School of Business, updates a record of annual returns for equities, bonds and cash every year. In 2022, his figures show US stocks suffered a hefty loss, down 18%. Cash (represented by three-month treasury bills) rose 2%.

However, this was a blip. Go back as far as 1928 and cash only outperformed equities by this big a gap eight times. Equities normally fare better, and quite often by a large margin. In monetary terms, US$100 invested in US equities at the beginning of 1928 would be worth more than £624,000 by the end of 2022. Cash, just US$2,140. [2]


Source: https://www.stern.nyu.edu/~adamodar/pc/datasets/histretSP.xls. Difference between annual returns for S&P 500 (including dividends) and US 3-month Treasury Bills.

And then there’s the inflation effect. According to Vanguard, between 1901 and 2022, the inflation-adjusted average annual return for cash was 0.87%. UK shares rose a healthier 5% per year. As the table shows below, once inflation is taken into account, cash has roughly the same chance of negative returns in a calendar year as equities, but a much lower growth potential (although UK shares still had the largest annual loss).[3]

The inflation effect. Nominal vs inflation-adjusted (real) returns

Source: Vanguard. Uses Dimson-Marsh-Staunton global returns data from Morningstar. UK shares represented by DMS UK Equity Index, UK bonds DMS UK Bond Index, DMS World Bill Index).UK Bills are used as a proxy for cash. Greatest annual loss represented by the lowest 5th percentile of annual returns. Returns in GBP. Nominal value is the return before adjustment for inflation with dividends and income reinvested; real value includes the effect of inflation. Past performance is not a guarantee of future returns. Data cover 31 December 1900 to 31 December 2022.

Market timing is much harder than it looks

Timing the market to take advantage when ‘cash is king’ is easier said than done. Even if this strategy sometimes yields short-term gains, getting it right every time is another matter.

You need to second-guess a huge amount of variables, including economic indicators, geopolitical events and investor sentiment, to predict when to buy and sell. And even if you strike it lucky, more frequent trading means you’re liable for higher transaction costs, such as broker fees and taxes, eating away at any potential gains.

Then there’s the opportunity cost. Market recoveries tend to be quick. Missing just a few days of a strong rebound would significantly reduce overall returns.

Switching to cash is a gamble that is unlikely to pay off

Safe to say, the longer you play the short-term game, the more likely you are to lose.

It’s like betting on something as unpredictable as a football match. All-conquering Manchester City have won four Premier League titles in a row, (and in 2023, the European Cup and FA Cup). But last season they lost home and away to Brentford. There’s no such thing as a sure-fire winner.

Over short periods, cash can look as if it’s doing better, but investing for your future is a long-term venture. Even if current valuations make you feel nervous, I advise clients to focus on their WealthMap goals and only make changes if we think it’s truly necessary. A well-diversified, buy-and-hold approach that aligns with your long-term financial goals and risk tolerance is everything you need to achieve your aims, so why roll the dice?

[1] Debunking Economics: The Naked Emperor Dethroned?, Professor Steve Keen, revised edition 2011.

[2] Source: Historical Returns on Stocks, Bonds and Bills: 1928-2022, Aswath Damodaran, Stern School of Business, NYU

[3] Source: Vanguard

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