View more on these topics

Paul Lewis: Cash is not king but at least it won’t disappear

Lewis-Paul

I tried recently to explain the virtues of cash to a hall full of financial advisers. It was hard going. Not least because some seemed determined to misunderstand me and then argue against not what I had said but their misunderstanding of it. Sigh. So, here goes again…

Cash has its place. Not just for that old financial journalist cliché of keeping three months’ salary for contingencies but for serious, dare I say it, investing.

Ok, that sounds like a bit of contradiction in terms, as saving and investing are different, so let’s call it “serious money in cash” rather than “investments”. Cash may not be king but it has an important place in the financial court.

It is not every adviser’s favourite asset class, and it is one many do not know a lot about, but its first merit is this: it does not disappear. You put £10,000 in a bank for a year when you do not need it and 12 months later, when you do, it is still there. All of it. Guaranteed.

Second, cash makes real returns. At the end of that one-year bond, the bank will add £200. That is £200 for doing nothing. From April, that will be tax free for 95 per cent of savers. If you tie it up for longer, you can get £300 a year. Take a look at day to day cash savings rates online; I bet they will be a lot higher than you expect.

Third, whatever the return on a fixed-term bond, it is known at the start and guaranteed: two things that are very rare in honest financial products. Finally, no one will take any charges from it. It does not need managing, there is no turn on buying and selling, and no brokers or advisers to take a cut. What investment can match that? None.

“Ah yes,” my interlocutors said, “but what about inflation? Your £10,000 will not be worth £10,000 after five years, will it? That is the risk with cash.”

Now, I am not going to say inflation does not erode the value of capital. Of course it does. But it erodes invested money as fast and to exactly the same extent as saved money. If the income is taken out, £10,000 in shares which, after deducting charges, is worth £10,000 in five years will have been eroded in real value identically with that cash. If inflation is 2 per cent a year, then by 2020 both will be worth about £9,000.

Advisers are sometimes stuck in the past when it comes to inflation rates. Some I spoke to recently told me the value of money halved every 10 years, which is an inflation rate of 6.7 per cent – something we have not seen since 1991.

In fact, at the Bank of England target of 2 per cent, it will take 34 years for the value of money to halve. This century, RPI inflation has averaged 2.9 per cent and CPI 2.1 per cent. But let’s say it again: whatever inflation is it erodes investments at the same rate as it erodes savings.

Of course, the hope is that invested money will grow faster than savings. If I had an infinite time, or indeed just a whole lifetime, shares would be the place for me. But over five years? What are the chances it will have grown at all after charges, never mind faster than cash?

A quick look at the FTSE 100 index – without adding dividends or deducting charges – shows that, in any random five-year period from 1995, the chances are less than even that the index will have beaten the 3 per cent a year guaranteed available on a five-year cash bond.

That is the nature of risk: risk does not mean reward. It may bring a reward; it may bring a loss. It is symmetrical. Especially over a short period.

And shorter periods are when cash comes into its own. This is particularly true at that phase we now call decumulation: the time between retirement and death when you live on the money that has been carefully accumulated over a working life into a pension.

Indeed, when you are in your last years you do not want money to grow and you do not want to add to it. You just want it to be there. A bit of growth may be nice but the key in decumulation is certainty. Strong growth may make your money last a couple more years but it is the extraction rate that matters.

“Ah-ha,” my interlocutors say, “but cash funds you can put pensions into pay almost nothing.” I agree: cash funds are a con, returning well under 1 per cent and charging about the same.

However, there are dozens of actual cash accounts with banks and building societies that can be used for pension funds in Sipps or drawdown. The best over five years pays 2.9 per cent, over three years, you can get 2.5 per cent and over one year, 2 per cent.

All are protected up to £75,000 by the Financial Services Compensation Scheme so, in using a number of them, you can set up a safe regular withdrawal plan as the bonds mature. Not all Sipp providers, including some of the best known ones, will allow cash deposits to be held but more than 50 will.

So while cash may not be everything, for most customers, especially older ones, it certainly should be something.

Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s ‘Money Box’ programme. Follow him on twitter @paullewismoney

Recommended

Steve_Groves_Partnership
2

Partnership chief slams ‘frustrating’ FCA advice gap delays

The Government and the FCA have been labelled “frustrating” and accused of “navel gazing” for for failing to deliver a solution to the advice gap. Speaking at the Institute of Financial Planning’s annual conference in Newport today, Partnership chief executive Steve Groves said it is time for the regulator to “step up to the plate” […]

HM-Treasury-500x320.jpg

Govt unveils plans for £2bn Lloyds retail offer

The Treasury has revealed its plans to offer at least £2bn of Lloyds Banking Group shares to retail investors. The retail offer will be launched in the spring, with applications available online or by post. The Government says it plans to sell down its remaining stake in Lloyds in the coming months. Members of the […]

2

John Lawson: The delicate balancing act of pension tax relief reform

To change to a new regime of pension tax relief, we would have to find a method (or methods) of dealing with benefits accrued under the old system. There are two potential ways to do this: to grandfather benefits already accrued, or to transfer existing benefits into the new world. Grandfathering is the traditional method of […]

Is three a crowd?

The pension versus Isa debate has raged on and off for years. Les Cameron, head of technical at Prudential, asks if three’s a crowd.   I think the debate was arguably settled by pensions freedom when the biggest downside of pensions – limited access and poor death benefits – was fundamentally changed. Total access, albeit with […]

Newsletter

News and expert analysis straight to your inbox

Sign up

Comments

There are 12 comments at the moment, we would love to hear your opinion too.

  1. “Finally, no one will take any charges from it [a bank account].”

    *facepalm*

    “That is the nature of risk: risk does not mean reward. It may bring a reward; it may bring a loss. It is symmetrical.”

    *double facepalm*

    “A quick look at the FTSE 100 index – without adding dividends or deducting charges – shows that, in any random five-year period from 1995, the chances are less than even that the index will have beaten the 3 per cent a year guaranteed available on a five-year cash bond.”

    *bangs head on desk*

    If you disregard dividends in the FTSE 100 Index then you also have to disregard the 3% interest on the five-year cash bond. If you exclude income from one you must exclude income from the other. The correct comparison is not 3% a year but zero. You are not so much comparing apples with oranges as compariing apples with orange peel.

    There is a kernel of truth in the article but it is surrounded by too much dumbness typical of the consumer financial journalist. Don’t worry about being accurate, just say it with confidence and people will have forgotten by next week’s show.

  2. “Third, whatever the return on a fixed-term bond, it is known at the start and guaranteed: two things that are very rare in honest financial products.”

    Just like an annuity?

    “Finally, no one will take any charges from it. It does not need managing, there is no turn on buying and selling, and no brokers or advisers to take a cut. What investment can match that? None.”

    What about an annuity? It doesn’t need managing either, so no buying or selling or worrying about chasing rates every few years. The charges are implicit (like a savings bond) and your annuity is likely to pay double or more your savings bond rate.

    Isn’t the key point here about what the user wants. If the capital is far more important than the income, by all means use a savings bond. But if income is important – and especially security of income over the years of retirement – then parking large sums in cash is a comparatively expensive option, one probably only the rich can afford.

  3. I agree with Sascha. In addition ‘most customers’ won’t be clients of IFAs because they don’t have enough money to make it worth their while. Most customers of IFAs are likely to be investors well into their retirement, an event that causes a switch from growth to income but no fundamental change in the long term underlying investment needs. That’s not to say some customers may prefer the cash and annuity route but it’s unlikely to be suitable for the typical IFA client with a large pension pot.

  4. Whilst I agree that holding cash as an investment makes sense for some clients, it worries me when an analogy is based on ignoring the income of shares and cash given that cash cannot change in capital value whereas investments of course can. I use the word ‘change’ rather than ‘grow’ to give a balanced debate.

    If the the debate is that capital value is irrelevant to the debate and income is the sole focus then surely we just stick everything in high yield and be damned with the capital value!

    In reality, cash gives income and other assets offer income and the potential for capital returns.

    AFAIK it’s accepted wisdom that cash generally does not deliver ‘real returns’ – this being defined typically as ‘above inflation’ – but investments offer the scope to achieve ‘real returns’ or, failing that, ‘above cash returns’.

    If we want to give a fair comparison between cash and investments, Banks need to disclose the margins on the interest they pay depositors and the returns they make in putting that cash to work – no doubt lending that cash to businesses just like investors do when buying shares!

    Furthermore, many older clients are looking at providing a nest egg to their beneficiaries and therefore, with their safety net in place, their investment objectives often turn to planning for that transfer of wealth – in fact, I would propose that clients risk appetite can even increase as they age for this very reason (I had one such discussion with a potential client this week).

    Whilst I therefore agree with the fundamental steer of the article (there is a place for cash) I disagree with some of the arguments used.

  5. Yet another load of sensationalist codswallop from someone who has never provided advice to a client in his life, nor having done so, ever taken responsibility for what he’s recommended.

    Surely, in order to provide a ‘balanced’ view of cash vs equities, if he’s going to include interest paid on a Bank Deposit a/c, then I would have expected that Mr Lewis would have done the decent thing and compared cash plus interest (less tax where payable of course) to a fund less charges but with income (i.e. divs etc) re-invested. I would expect this to provide a very different picture than he has painted, otherwise I might as well pack up and go and train as a financial journalist.

  6. I agree with most of your comments as usual Paul, however, my understanding is that the £75,000 FSCS protection is provided to the SIPP provider, not the individual SIPP members, or have I got this wrong?

  7. Cash is NOT safe! Take a look at ‘Retirement Inflation’ where the income is spent on Utilities, Fuel, Food, Insurances, Council Tax, Leisure/Family. It won’t be average of 2%, more like 5% over the past 10 years. If you have interest of 1-2% and Inflation of 4-5%, then 3% net inflation over 10 years, means 37% loss in the value of your money. Safe/ Pah! Next he will be saying that Premium Bonds are ‘safe’ and good value. To have Govt. encouraging its people to gamble with their savings is inexcusable. Govt. should Issue more Index Linked Bonds not increase the amount of Premium Bonds that can be held and gambled upon. Paul Lewis is a sound bite expert with no qualifications and all financial journalists should be made to have a Diploma qualification before being allowed to comment/advise the general public. Paul, some people only think you are an idiot, best not to open your mouth/column and confirm it!

  8. Most of the sound arguments have already been made above but the telling point is that, given that dividends have historically contributed 70-75% to overall equity returns for longer term investors, it is both facile and spurious to omit this contribution from any comparison.

  9. whilst the things he says to justify his arguments are not fair comparisons the underlying comments are true. The danger is that his comparisons are not like for like and therefore if used with the general public rather than a trade publication could be misleading. However, he is right to highlight the value of having some money in cash as an investment in certain situations.

  10. I think Paul is right to the extent that cash should be an important part of a portfolio, depending on what the clients objectives etc. But to suggest that there are no charges on bank accounts is a little naive. Perhaps it is right to say that there are no explicit charges on fixed rate bonds. But it has always been the case that what the bank lends at and what it accepts deposits at are widely different and this is the “charge” of a deposit. The fact that it isn’t disclosed doesn’t mean that it doesn’t exist…

Leave a comment