Over the last two years, financial advisers have been asked the same recurring question from clients: Shall I encash my investments to take advantage of higher interest rates offered by the banks? There are several factors that must be considered, but most of the time the answer to this question is no. Let me explain why.

Over the last five years we have experienced several market events in quick succession:

• Brexit: 31 January 2020
• First COVID lockdown: 26 March 2020
• Russia’s invasion of Ukraine: 24 February 2022
• Hamas attacks on Israel: 7 October 2023

To try and put into perspective how global equities have performed in developed markets of late, by using the MSCI World benchmark as an example, we have seen two negative calendar years (2018 and 2022) in the last five. Putting that into context, over the last 14 years there have only been three negative years (2011, 2018 and 2022). Naturally, this has shocked investors into life as they remember that stocks and shares investment returns are not linear, they do in fact go up and down, and cash deposit rates have become more attractive.

Inflation and interest rates

It’s natural for us, as humans, to not enjoy seeing losses, yet those who have chosen not to invest in stocks and shares, will have seen returns in UK deposit accounts close to 0% for the past 15 years, up to 2022. Yes, you would not see the value of your cash deposits go down, however, inflation will have eroded these returns. At time of writing, the Bank of England base rate sits at 5.25% and inflation is at 4.60%.

The Bank of England expects inflation to keep falling in 2024 and should reach their target of 2.5% by the end of 2025. Should they be correct, these higher interest rates may not be around for too much longer.

Investing for the long term

Cash vs stocks – from 1925 to 2023 cash would have provided an annualised return of around 5%. Over the same period a Growth Portfolio (made up of 60% equities 10% emerging markets and 30% global bonds) would have provided an annualised return of around 11% (annualised rates of return based on Timeline's Money for Life chart).

There are many reasons why people would be nervous to invest over the last century, but the fact is, cash deposits have not kept up with most stocks and shares investments over the longer term.

Psychologically, staying invested allows investors to overcome behavioural biases such as greed and fear. It is important, and part of our job as financial planners, to ensure clients are comfortable with investment risk if they are to invest, and to discuss this regularly.

Time in the market

There is a well-known saying “Time in the market, not timing the market”. Yes, it would be ideal if we all knew when to put money into the market, however, nobody has a crystal ball. There will always be factors that will worry investors and professionals putting money into the market, but the danger is that you are wrong and miss out on valuable investment growth. Take 2020 as an example, the start of the COVID pandemic. The MSCI World Index increased by 15.9% that year, I would have thought not many people would have predicted that.

What we do know from history is that financial markets are resilient and are able to rebound from economic downturns. Staying invested allows you to be a part of the economic rebound and benefit from the potential upside.

Diversification

We believe that you shouldn’t hold all of your eggs in one basket. By spreading investments across various asset classes, we can reduce the risk of our client’s portfolios. It is important to hold a good amount of cash assets, if they are required in the shorter term, but I would encourage investors to try and obtain the best cash rates available to ensure your cash deposits are keeping as close to reported inflation.

Personal savings allowance

An important reminder to those who hold cash deposits - as interest rates have increased, more people are paying tax on their cash savings. A basic rate taxpayer can earn £1,000 per annum in savings before paying any tax on it, and higher rate taxpayers can earn £500 in interest. If you are an additional rate taxpayer, you will not benefit from this allowance.

ISA allowance

Everyone can contribute up to £20,000 into an ISA this tax year. Typically, non-ISA cash-based products are currently offering slightly higher rates than ISAs, however, it is worthwhile considering the net interest that you will receive, especially if you are a taxpayer. Below is an example of what a client would earn if they invested £100,000 in a fixed rate bond at 5%.

As demonstrated in the example above, it is unlikely anyone will receive the full 5%. A basic, higher, and additional rate taxpayer in this example will earn 4.2%, 3.2%, and 2.75% respectively. This stresses the importance, in particular for higher and additional rate taxpayers, to consider using their ISA allowances if available.

Conclusion

From experience, most people turn to the stock market with the aim to achieve returns in excess of cash-based savings and inflation over the longer term. In financial planning, there is a place for both cash deposits, and stocks and shares investments to diversify client’s assets.

The key advantage of cash in this market is that you know what your returns will be, the banks are offering credible interest rates and you can tend to access at short notice in case of an emergency without having to crystallise losses.

It has been proven that if you hold a well-balanced portfolio of investments over the longer term, they are likely to have provided growth more than cash-based deposits. It is important to note that if you hold invested assets, it is sensible to sit tight and ride out volatile markets for better times if able to do so. That is why, broadly speaking, financial planners will discuss time horizon, attitude to risk, and capacity for loss to ensure investing is appropriate for clients on an ongoing basis.

It is encouraging that there are lots of cash-based and investment opportunities in the current market. It allows us as financial planners to consider all options for our clients and if we think cash-based solutions are best for our clients, we will suggest them based on each individual circumstance.

To go back to my original question, shall I encash my investments to take advantage of higher interest rates offered by the banks? My answer: generally speaking, no, but it depends on each individual circumstance. If you are unsure, please don’t hesitate to get in touch with myself or a member of our Wealth team.

Disclaimer

Johnston Carmichael Wealth Limited is authorised and regulated by the Financial Conduct Authority.

Please note: This communication should not be read as financial advice. While all possible care is taken in the completion of this  article, no responsibility for loss occasioned by any person acting or refraining from action as a result of the information contained herein can be accepted by this firm. 

Figures refer to the past and past performance is not a reliable indicator of future results. You may not get back the full amount of your investment.