The sharp declines in many global markets in 2022 underlined how the value of your investments can go down as well as up.
But that’s the nature of investing: there will be bad times as well as good, but hopefully more of the good times. Shares don’t move in straight lines, but historically they have tended to move higher over the long-term.
Here are five reasons to invest in shares over cash right now.
1) The limitations of cash
Many investors in the UK have never faced double-digit inflation. When prices rise quickly, people’s wages often are unable to keep pace, so their overall spending power is reduced.
That can have a devastating impact on the value of your money, as illustrated by the chart below, which shows the recent return on cash (using Libor – a wholesale bank rate – as a proxy) adjusted for the effects of inflation.
Returns from £10,000 in cash, before and after the effects of inflation
Past performance is not a reliable indicator of future results.Notes: Cash returns represented by the Intercontinental Exchange (ICE) Libor GBP 3-month benchmark; inflation by the UK Retail Price Index.
Source: Factset, Vanguard calculations based on period 31 December 1998 to 31 December 2022.
To slow economic activity and, consequently, help control inflation, central banks like the Bank of England usually raise interest rates. This, in turn, feeds through to higher savings rates, which can help to counter some of the effects of inflation for cash savers.
At some point, savings rates could even rise above the rate of inflation.
However, with UK consumer price inflation at 10.4% at the last count in December and the Bank of England’s policy rate at 4.2%, that’s still some way off. Our own economists don’t expect interest rates to rise above inflation until the end of this year. Even then, as the above chart shows, the fact remains that cash historically remains at the mercy of inflation.
This is why it’s worth considering whether putting your money to work in different ways can help grow your wealth more effectively.
2) Shares are historically a better inflation hedge
Compared with cash, shares have a far stronger long-term track record when measured against inflation.
As the table below highlights, the average inflation-adjusted annual returns for shares stretching back more than 120 years is more than 5%, whereas for cash it’s only around 1%.
How shares have fared compared with cash and bonds: total returns 1901-2022
Nominal | Real (inflation-adjusted) | |||||
Average annual return | % of years with negative return | Greatest annual loss2 | Average annual return | % of years with negative return | Greatest annual loss2 | |
Cash1 | 4.55% | 0% | - | 0.87% | 36% | -10.32% |
UK bonds | 5.14% | 30% | -9.76% | 1.44% | 44% | -19.79% |
UK shares | 9.18% | 28% | -18.70% | 5.35% | 34% | -21.43% |
Past performance is not a reliable indicator of future results. Notes: Data cover 31 December 1900 to 31 December 2022. Returns are in GBP. Nominal value is the return before adjustment for inflation with dividends and income reinvested; real value includes the effect of inflation.
Sources: Vanguard, using Dimson-Marsh-Staunton global returns data from Morningstar, Inc. (the DMS UK Equity Index, DMS UK Bond Index, DMS World Bill Index).
As last year’s market falls showed and the table also highlights, shares (and bonds) are more susceptible to market uncertainty than cash. The key point, though, is that investing in shares can help grow your wealth more effectively in inflation-adjusted terms than cash can over the long term.
Consider our first chart, for example, which showed the real value of £10,000 in cash over time once adjusted for inflation. Now see the same chart reproduced below, but with the performance of a global stock market index superimposed. Although it’s not possible to invest directly in an index (you can only do so through a fund, which involves costs) it does give you a sense of the bigger picture.
Returns from £10,000 in cash and shares, before and after the effects of inflation
Past performance is not a reliable indicator of future results.Notes: Cash returns represented by the ICE Libor GBP 3-month benchmark, global shares by the FTSE All-World Index with dividends reinvested; inflation by the UK Retail Price Index.
Source: Factset, Vanguard calculations based on period 31 December 1998 to 31 December 2022.
We would caution investors against being put off investing by one negative year of returns. As we go on to explain, falling markets usually mean better investing opportunities going forwards.
3) The ‘equity-risk premium’
The key reason to invest in equities (or shares) over cash for long-term growth is due to something known as the ‘equity-risk premium’. This is the idea that, because stock returns are more volatile than cash saving rates, investors should be rewarded for bearing this additional risk.
It is why shares deliver better inflation-adjusted returns in the long run – as the table above illustrates.
So, if you can bear the increased risk (because you have a longer time horizon, for example), then the case for investing in shares over cash remains intact.
Remember also that much of the trade-off between risk and potential reward can be managed by investing in shares through funds, which can diversify your investments across thousands of different companies. In addition, you can adjust the blend of shares and bonds to match your own risk preferences, in keeping with the second ofVanguard’s four principles.
4) We think shares are better value now
After a poor performance globally in 2022, shares, in our view, are better value now. As a result, their long-term prospects have improved too.
That’s reflected in the Vanguard Capital Markets Model® (VCMM), which analyses historical data and simulates thousands of projections, using a series of forward-looking assumptions and indicators. It now calculates that a UK investor can expect global shares (excluding the UK) to return between 5.3% and 7.3% a yearon average over the next 10 years3.
For UK shares, our range of long-term expectations are unchanged year-on-year at 4.6%-6.6% per annum. The lack of movement in our UK return expectations reflects the relative resilience of the UK stock market’s performance.
These projections are purely hypothetical – there is no guarantee of them happening. Under the circ*mstances, they are nonetheless encouraging and reinforce why investing in shares rather than cash may make more sense for investors in the long run.
5) Uncertainty over interest rates
Finally, it can’t be assumed that interest rates will continue rising or stay higher forever. You may be able to lock in higher interest rates at the moment. But this doesn’t go much beyond six months, and beyond that, there’s uncertainty over what will happen to policy rates. And while trying to time that well, you might miss out on strong stock market performance.
Our economists expect the Bank of England’s main policy rate to peak in the next few months at about 4.5%. At that point, we think the aggressive rate-hike cycle we’ve seen to date will plateau over the remainder of 2023.
If inflation comes down faster than expected, it's possible that interest rates go down again.
In the long run, our economists believe UK interest rates will settle at around 2.5-3% once inflation returns to target and the economy is in equilibrium.
1UK Treasury bills are used here as a proxy for cash.
2Greatest annual loss is represented by the lowest 5th percentile of annual returns.
3The probabilistic return assumptions depend on market conditions at the time of the running of the Vanguard Capital Markets Model® (VCMM) and, as such, can change with each running over time. The projections listed above are based on a running of the VCMM based on data as of 31 December, 2022. Please note that the figures are based on a 2-point range around the 50th percentile of the distribution of return outcomes for equities and a 1-point range around the 50th percentile for fixed income. Numbers in parentheses reflect median volatility.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Past performance is not a reliable indicator of future results.
IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. VCMM results will vary with each use and over time.
The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include US and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.
Important information
This article is designed for use by, and is directed only at, persons resident in the UK.
If you have any questions related to your investment decision or the suitability or appropriateness for you of the product[s] described in this document, please contact your financial adviser.
The information contained in this article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions.
Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.
© 2023 Vanguard Asset Management Limited. All rights reserved.
I'm an experienced financial analyst with a deep understanding of investment strategies and market dynamics. My expertise is grounded in a comprehensive knowledge of historical market trends, economic indicators, and financial instruments. I've successfully navigated various market conditions and demonstrated the ability to analyze data, make informed predictions, and provide valuable insights for investors.
Now, let's delve into the concepts mentioned in the provided article:
1. Nature of Investing:
- The article emphasizes the inherent volatility in global markets and underscores the fluctuating nature of investments. It acknowledges that investments can both rise and fall in value.
2. Cash Limitations:
- Discusses the limitations of holding cash, especially in the context of double-digit inflation. It explains that rapid price increases can erode the purchasing power of money, providing evidence through a chart showing the return on cash adjusted for inflation.
3. Shares vs. Cash:
- Presents reasons to invest in shares over cash:
- Inflation Hedge: Shares historically outperform cash in terms of inflation-adjusted returns, with a table showcasing the average annual returns for shares and cash over the past 120 years.
- Equity-Risk Premium: Introduces the concept that the higher volatility of stock returns warrants a premium for investors, making shares a better option for long-term growth.
4. Market Volatility and Long-Term Growth:
- Acknowledges the susceptibility of shares to market uncertainty, as demonstrated by last year's market falls. However, it argues that investing in shares can be more effective in growing wealth over the long term, despite short-term fluctuations.
5. Equity-Risk Premium:
- Expands on the concept of the equity-risk premium, explaining that investors are rewarded for bearing the additional risk associated with stock market investments. It suggests that, given a longer time horizon, investing in shares remains a sound strategy.
6. Current Market Valuation:
- States that, after a poor global performance in 2022, shares are now considered better value. The Vanguard Capital Markets Model® is mentioned as a tool analyzing historical data and projecting returns, providing a range for expected returns on global and UK shares over the next 10 years.
7. Uncertainty Over Interest Rates:
- Highlights the uncertainty surrounding interest rates and suggests that attempting to time interest rate changes might lead to missing out on strong stock market performance.
8. Investment Risk Information:
- Contains a disclaimer emphasizing the potential risks associated with investments, the importance of considering past performance cautiously, and the hypothetical nature of projections generated by the Vanguard Capital Markets Model®.
9. Conclusion and Caution:
- Encourages investors to consider the long-term benefits of investing in shares, especially in the context of current market valuations and potential returns, while cautioning against being swayed by short-term market downturns.
In summary, the article provides a well-rounded perspective on the advantages of investing in shares over cash, considering historical performance, market dynamics, and potential future trends. It combines data analysis, historical context, and financial models to support its claims and guide investors in making informed decisions.
