If you think that interest rates could potentially rise two or three times in the next two to three years, you may consider moving your funds – or a chunk of your money – into a savings account. But it is best not to act rashly.
It’s important to contemplate what you need your money for. A bank account is perfectly acceptable for funds that require frequent access (such as living expenses) and we certainly believe cash has an important role to play as a portion of your total portfolio. Yet when it comes to preparing for longer-term goals, it is critical that your capital can deliver the required returns.
And if you examine the figures, investing is still the best way to achieve this.
The stock market typically outperforms cash
Between the second quarter of 1999 and the end of 2010, the average interest rate from a cash ISA account1 was 4.0%. Since then the average has been 1.35% and it is currently 0.7%.
The official Bank rate (as set by the Bank of England), on average, over the same period has been 2.65%. However, this has been significantly lower since the global financial crisis.
The annualised total return from the FTSE 100 has been 4.6% a year, despite experiencing two severe bear markets over the period.
But now the Bank has started a path to normalise rates (moving to what they term more typical levels), investors may wonder whether it is prudent to sell their investments and transfer their funds into a typical savings account.
Why inflation means you should invest, and stay invested
Inflation burns a hole in your pocket. And while the rate of inflation – and its effect – varies over time its impact can be clearly assessed over the long term.
One of the main goals of investing, therefore, is to meaningfully outpace inflation, so the real value of your assets is not depleted. Not since late 2009 has putting your money in a savings account achieved that objective, and so your capital may not maintain its purchasing power.
We can see in the chart below how inflation has far outpaced the rate realised on savings since the crisis and it is our expectation, and the Bank’s, that interest rates and consequentially returns on savings accounts, will be much lower than pre-crisis levels.
Source: Bank of England, Bloomberg, Netwealth calculations.
Therefore, rather than relying on cash products to generate real returns, we believe an alternative approach is required. Indeed, between the end of 2007 and 2017, if you had left £100,000 languishing in a bank account its actual purchasing power – after retail price inflation – would have slumped to £91,4702. Alternatively, if you had invested that money in a medium risk portfolio it would have risen to £122,9053.
Of course, the benefits of investing are only fully realised if you actually stay invested. One of the most notable drags on returns is when investors aim to ‘time the market’ – trying to predict when the stock market or specific shares will go up or down, and acting accordingly.
This strategy inevitably leads to trouble: those who stay invested have typically outperformed those who dip in and out by at least twice as much over time, as we show here.
Finally, while investors tend to be cautious in a period of rising rates, historical data shows that in the subsequent period after the Bank of England has increased interest rates, UK equities have performed well. Between 1983 and 2017, of the 39 months where the Bank has hiked, on 30 occasions FTSE 100 returns have been positive in the following six months.4
Source: Bank of England, Netwealth calculations.
So, if you are thinking that interest rate rises may be a reason to consider moving your funds, it’s worth interrogating the figures. Only then is it possible to see past the headlines, and the noise created by a rate rise – and objectively assess whether putting your money in a bank account will help you to achieve your goals.
Please note that past performance is not indicative of future performance. Simulated historic returns are based on current strategic allocations, historical asset class index returns and an estimate of costs and charges associated with investing.
Please remember that when investing your capital is at risk.
1 Source: Bank of England, Netwealth calculations. Prior to 2010 the interest rates were compiled using branch-based rates only. Since 2011, reflecting the change in consumer behaviour, the Bank now compiles data from internet-based products only. Further details can be found here. We have based our analysis using Cash ISA interest rates since they typically receive a higher interest rate than an instant access deposit account.
2 Return calculated as the total return on the UK 12m LIBOR Cash Index, deflated by RPI, for UK Cash.
3 The Netwealth Risk Level 4 return series is the simulated performance of the current strategic allocation, net of management fees and underlying fund costs, deflated by RPI.
4 Where there has been more than one rate hike in a month these have been combined. Returns are calculated using month end data for the FTSE 100 Total Return Index.