How Reckless Caution Can Wreak Havoc on even Careful Investors

Having too much cash may seem like a nice problem to have, but holding too much of our wealth in cash – like in a Cash ISA, or bank account – could be an issue. In fact, we can use the term ‘reckless caution’ to illustrate the dangers of playing it too safe with our finances.

Holding cash can make perfect sense, especially for short-term money management and easy access – but to efficiently grow our money over the long term, we should think carefully about how to allocate our funds effectively.

The ISA season often prompts investors to think about what to do with their savings. But we’re clearly not doing enough: the latest figures from HMRC show that in the 2017-2018 tax year, 57% of money invested went into Cash ISAs – with Cash ISAs accounting for 72% of the ISA accounts funded in the year¹.

Why does this matter?

Moneyfacts figures show that the average rate for a fixed 1-year cash ISA is 1.35%². The most recent inflation figure (January 2019) showed that the Consumer Prices Index rose 1.8% over a year according to the Office for National Statistics.

So over time, the imbalance between the cost of living and what you may typically receive in a Cash ISA will gradually deplete your pot.

Leave your money nestled in a bank account and you won’t fare any better.

Let’s take the period from the end of 2007 to the end of 2018, a time of strong growth for the stock market overall, but also involving a considerable decline. If you had left your nominal £100,000 lounging in a bank account its actual purchasing power – after retail price inflation – would have slumped to £82,299. By investing in a balanced portfolio on the other hand, such as Netwealth’s medium risk portfolio (Risk Level 4), your capital would have risen to £117,822 over the same period. (The gap is much broader over 10 years – £78,757 vs £138,703 – but for transparency we want to capture the full effect of the financial crisis.)

While savings erode over time, a balanced portfolio could be the solution

Source: Bloomberg, Netwealth Investments' Calculations
Return series are calculated as the total return on the UK 1m LIBOR Cash Index, deflated by RPI, for UK Cash. The Netwealth Risk Level 4 return series is the simulated historical performance of the current strategic allocation, net of management fees and underlying fund costs, deflated by RPI. Past performance is no guarantee of future performance.

Since the end of 1984 global equities have returned in excess of 8% annually³. And while the level of future returns is not guaranteed, it is clear that by taking some risk – aiming to capture some of the long-term growth of equities – gives you a much better chance of protecting against the effects of inflation compared to cash.

How you can counteract reckless caution and combat inflation now

Of course, not everyone is comfortable taking risk, even if they intuitively know it is the right thing to do to protect their money over the long term. This is why using professionals to invest on your behalf can help you get started with more confidence.

"We give investors a choice of seven diversified portfolios with different risk levels," says Iain Barnes, Netwealth’s head of portfolio management. "This means that investors can choose from very low risk, which invests mainly in high quality, often short-dated bond funds, to a portfolio that is concentrated in growth assets like equities – with various mixes of investments, and therefore levels of risk, in portfolios between these two poles."

Because you can tailor risk levels to suit your preferences, choosing to invest, therefore, is not a binary choice of yes or no. To avoid the depletion of your funds due to inflation, a low-cost, diversified portfolio managed for you could be an ideal option for your long-term investing needs.

Please remember that when investing your capital is at risk.

Sources:
¹ HMRC ISA statistics https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/737394/Full_Statistics_Release_August_2018.pdf
² Moneyfacts January 2019 ISA figures https://moneyfacts.co.uk/news/savings/average-one-year-isa-rate-increases-to-three-year-high/
³ MSCI World Total Return denominated in GBP, for the period 31-Dec-1984 to 31-Dec-2018.