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Stocks and Shares or Cash: which type of ISA is right for me?

2022 was a turbulent year and 2023 has begun in the same vein. The collapse of Silicon Valley Bank (SVB) and the buy-out of Credit Suisse are reminders that the financial crisis of 2008 was not a black swan event. Even banks are not as safe as we – or they – might like to think. Instability in the financial markets is a fact of life in the 21st century. Understandably, many investors feel cash is a safe place for their money. 

The most important thing to factor is your risk appetite and your time horizon. If you are saving for a short term goal, then lower risk options like cash should definitely be considered. However people with longer time horizons, for whom short term volatility is not relevant, can actually benefit from the recent fall in markets. 

Historically, natural investor behaviour shows that investors are happy to add money into markets when they are high and rallying and are more coy when markets have fallen. However, historically, investors who have done the opposite have performed best, but there are strong emotional biases to overcome in order to take this action.

A complex environment

Let’s start by confronting the elephant in the room. Many investments in stocks and shares suffered in 2022. Many stocks and shares ISAs reported overall falls in value. Bonds performed worst of all, especially UK index-linked gilts. As a result, investors may well have looked with envy at the performance of their peers with cash ISAs. 

And if you are only looking for a tax-free home in the very short-term, cash instruments offer a more interesting option today than in the recent past. After all, savings rates have reached heights not seen for more than a decade. And there are tempting deals available for cash ISA offering rates of more than 3% or even upwards of 4% for savers who agree to a fixed rate.

So why do we feel that this may not be a sensible investment approach for everyone?

Cash isn’t without it’s own risks

If you are looking to invest in an ISA before the 5th April deadline, a cash ISA might feel like a safe choice, while stocks and shares ISAs appear unreliable at best and risky at worst. That, at least, is what it can feel like. However, if you are investing for the long term, we suggest you consider looking beyond the current market volatility.

But Moneyfarm’s Strategic Asset Allocation 2023 report explains the two interrelated reasons why making decisions on short term volatility can lead to savers missing out, especially if they have a very long time horizon in front of them:

  1. We predict positive long-term expected returns for equity and fixed income investors (actually more positive than they have been in the past decade).
  2. The ‘real’ value of cash investments in the long-term is often more negative than appearances suggest.

As a result, cash investors could also be missing a valuable opportunity to invest intelligently rather than reactively – and to reap the rewards.

The pitfalls of cash

Of course, cash has its place in a balanced portfolio. Liquidity is necessary for ‘rainy day’ events. But in a world where inflation is the ever-present enemy, cash has rarely been a sensible investment for the long-term investor.

Even the slightest gap between interest rates and inflation means your money diminishes in value. We think it is reasonable to assume that with an assumption of just 2% inflation per year, the real value of £100,000 left in an account could be less than £78,000 within 10 years.

Even within the next year, with current levels of inflation, your capital could lose over 10% of its purchasing power. And unlike losses made on stocks and shares, that value is not going to be recovered through an upturn in the markets. There is no capital growth nor the positive impact of dividends.

Even the short-term looks negative for cash

It is no secret that central banks have raised interest rates in recent months to combat inflation. This seems to be working, and there is a prospect of inflation dropping closer to 2% by the year end.

However, the recent collapse of SVB and the ripples of concern across the banking sector and the wider economy has led to an injection of liquidity by the Federal Reserve. This creates a two-pronged risk to cash:

  1. Lower interest rates
  2. Potentially higher than expected levels of inflation

Neither is likely to be good news for your cash ISA.

Historically, investments have been the best performers – despite the volatility 

This negative noise around cash is balanced by our more positive outlook for the financial markets.

This is rooted in lessons from the past. Between 1930 and 2022, there were 71 positive years for stocks and shares, versus 21 negative years. A Barclays Equity Gilt study in 2016 demonstrated that over the previous 50 years, stocks and shares had returned 5.4% per year, compared to cash at 1.9%. Stocks and shares beat cash 75% of the time when held for five years, rising to 91% when held for 10 years and 99% when held for 18 years. Even though past performance is not a guarantee of future returns, these numbers are significant  when considering your long term financial goals.

We are upbeat about the long term

While recent weak financial markets can make people nervous, there is an upside. Our 2023 Strategic Asset Allocation paper looks at the reaction to significant falls in the markets, including the dot.com crash, the 2008-9 credit crunch and Covid. Each had very different causes, but a similar outcome with markets bouncing-back impressively.

We believe that those with a long-term investment strategy should gain from a similar reaction in the future. As always, it is foolhardy to predict the precise timings, but we do believe that current valuations for stocks and shares are relatively low and well-placed to target capital growth.

In the next decade, we are particularly positive about potential returns in developed equity markets (where we predict annual growth of 8.3%) while emerging market equity investors could enjoy returns of 6.6% returns per year. Emerging market government bonds are set to return 6.4% a year while predicted returns for investment grade credit are attractive too at 4.8% a year (see chart below). Nothing, of course, is certain. Those are simply based on our expected return calculations. But it is a view upon which we are building our investment strategy.

How this affects your upcoming ISA investment

With only days to go before the deadline, you will want to utilise the tax-advantages of your ISA allowance. We appreciate that it isn’t a straightforward decision. It is one thing to believe in the long-term, but much harder to invest in stocks and shares at a time of volatility.

In a nutshell, for long term financial savings, we believe in the financials markets because:

  1. It has consistently produced better long-term returns than cash
  2. Investors can benefit from capital growth and dividend payments
  3. The cyclical nature of markets points to a rebound at some point
  4. Cash is not a particularly safe (or even neutral) place in the long-term as its real value decreases over time

As we state at the beginning, it is important to consider your overall risk appetite and time horizon when making a decision. If you are not sure, speak to one of our consultants, by booking an appointment here

Cashback when you invest

Having explained why cash isn’t our preference in the long-term, we would like to offer you up to £750 right now! Any deposits you make up until 30 April 2023 will count towards your total cashback reward, but remember, you have until 5 April to make the most of your ISA/JISA allowance for the current tax year.

There are more details here.

We are always happy to chat about any aspect of your investments. Please feel free to call us any time.

Capital at risk. Past performance and forecasts are no indicator of future performance. Tax treatment depends on your individual circumstances and may be subject to change in the future. You should seek financial advice if you are unsure about investing

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*Capital at risk. Tax treatment depends on your individual circumstances and may be subject to change in the future.