Cash is no longer the king as inflation shrinks our savings
THERE is something reassuring about money in the bank. Stowed away in a trusted institution, it is easily accessible and, when you make a withdrawal, you have it in your hand – it is tangible – and that can be very comforting.
No wonder then, that in times of uncertainty people tend to favour cash, believing it will protect their savings.
In contrast, when the economy is buoyant and financial forecasts look bright, investors are more relaxed about looking to stocks, shares and funds as a way of increasing their returns.
With Brexit drawing closer and signs of fragility emerging in the world economy (take Turkey’s recent currency crisis for instance), the future seems much less assured and it becomes more tempting to stockpile cash in the bank.
Unfortunately, though, putting money into a bank account is not risk-free either.
Why? Because of the effect of inflation.
Inflation quantifies the increase or decrease in the cost of living, measured by movements in the con-
Maybe it is time to make your money work for you, says Darryn Richards, an investment manager with wealth management company Brewin Dolphin
sumer price index.
When the cost of goods and services go up, everyone’s shopping basket and spending power is affected – yet generally speaking the impact is not given the attention it deserves.
Let’s take your monthly bank statement as an example.
It will show you how much cash you have got and how much interest you have earned, but it won’t provide an adjustment for what the balance is worth in real terms, after inflation is taken into account.
Yet inflation can be very damaging, gradually eroding the value of your money.
A more accurate bank statement would illustrate how much you have ‘lost’ through the decline in your savings’ purchasing power.
Let’s say you had £10,000 in cash ten years ago.
According to research carried out by Brewin Dolphin, the actual return on that figure, once inflation has been factored in, has averaged negative 1.80 per cent per year over the past decade.
Even removing the effects of tax, that is the equivalent of losing £180 annually at the outset.
And, after ten years, the total losses in terms of spending power would have totalled £1,663.
You are then left with a cash sum with a real value of just £8,337 – a 17 per cent decline.
This is because inflation has pushed up the cost of goods and services in the real world while the interest paid on your cash has failed to keep up.
And, of course, any tax you need to pay on your interest would reduce the returns still further.
The Office for National Statistics recently announced that inflation had risen for the first time since November 2017, to 2.5 per cent in July.
If it stays at that level for a decade, it would turn £10,000 today into the equivalent of just £7,763.30 – reducing the value of your money by almost a quarter.
With inflation far outpacing the Bank of England’s base interest rate of 0.75 per cent, savers are losing money every day.
So what should you be doing? There are numerous ways of protecting against the erosive effects of inflation, but none have been as consistent as investing in stocks and shares.
There is, of course, a risk to capital in every investment portfolio – however cautiously it is put together.
If stock markets fall, investors can end up with less than they put in.
That is why it is wise to view investing in equities as a five-year commitment at the very least, because taking that approach increases the likelihood of a positive return after inflation.
Broadly speaking, the opposite is true with cash: the longer it is in the bank, the more likely you are to have a negative real return thanks to inflation.
In fact, over the past ten years, after-inflation returns on shares have outperformed the equivalent on cash by 74 per cent.
With more than £200 billion currently languishing in cash ISAs, it is clear that during times of uncertainty many people feel safer knowing their money is in the bank.
There’s nothing wrong with that but, when inflation is rising, their wealth and purchasing power are effectively being diminished.
There is no question that having ready access to cash is important, for all sorts of obvious reasons.
When it comes to savings, however, an account nest egg may not prove as lucrative as professionallyadvised, long-term investment.
Neither comes with success guaranteed – especially given Brexit’s uncharted and potentially turbulent waters – but doing something to make your money work for you might be better than stashing it away, sitting back and hoping.