Ever since the Global Financial Crisis, the consequences for savers and investors have been profound. Policymakers slashed interest rates to near zero and printed vast quantities of new money to support our financial way of life. However, in the last two years, with the return of inflation, this approach has been reversed in the blink of an eye, bringing interest rates closer to historic norms. However, does this mean investing for the longer term has become unattractive? Simon Durling, from Santander Asset Management, shares his thoughts in this week’s State of Play.
Key highlights from this week’s State of Play
- Is cash now king?
- Why invest?
- Time in, not timing
- Time, patience and importantly persistence
Is cash now king?
This month, we are likely to see the Bank of England raise interest rates for the fifteenth (yes that is 15!) consecutive time since December 2021. If the Monetary Policy Committee raises rates by a further 0.25%, as anticipated, it will take the base rate to 5.5%, the highest since January 2008.1 In their commitment to tackling rising prices, policymakers have normalised interest rates at a breath-taking speed. In many respects, the speed at which they responded to the financial crisis has been mirrored by how quickly things have changed some 15 years later.1 This is the first such period of sustained ‘financial tightening’ (defined by less money in circulation and higher interest rates) we have seen since the Bank of England was appointed by Gordon Brown, the then Chancellor, in May 1997.2
Bank of England base rates since 2006
Last week, the Treasury-backed National Savings and Investments (NS&I) increased their savings rates by 1.2% on the 1-year guaranteed growth bond to 6.2%, the highest since the bonds were launched in 2008.3 This places NS&I at the very top of the savings best buy tables at the time of writing for 1-year fixed rate savings.4 Given that Santander now offers an easy access account paying 5.2%,5 many, especially those who have suffered from last year’s historic fall in bond values, may be asking - is investing worth the risk? Let’s step back and look in more detail at the balance between saving and investing and why investing still remains an important part of an overall long-term financial plan for many.
The importance of tax
Many savers may be delighted with the improvement in savings interest rates, but as I am sure we all know, how our savings or investments are taxed is a crucial element when considering what portion of your wealth is placed in a savings account and how much should be allocated for the long-term in an investment portfolio, assuming that is appropriate given your circumstances.
Clearly, ever since April 1999, savers and investors have had the advantage of their ISA allowance. The rules have evolved since their launch and now stand at £20,000 per person per tax year, whether this is in savings or investments. This allows savings interest to be tax-free in a cash ISA. If you invest in a Stocks and Shares ISA, it is tax-efficient but not tax-free. Anything outside of an ISA wrapper is subject to different taxation, depending on whether it is an investment or savings.
For savers, there is a personal savings allowance (PSA) which lets you earn interest on your savings without paying tax on that interest.6 The allowance you get depends on what rate of income tax you pay and while it sounds simple, it is always worth checking how you are affected individually depending on your financial circumstances:
- Basic-rate (20%) taxpayers: can earn £1,000 in savings interest per year with no tax
- Higher-rate (40%) taxpayers: can earn £500 in savings interest per year with no tax
- Additional-rate (45%) taxpayers: £0 – they do not get an allowance.6
The reason I highlight tax is because some may see a headline rate advertised and take that as the return they will receive on their savings. So, as a simple example, if you have £10,000 in savings and see a one-year fixed-rate savings bond account offering 5%, depending on your tax position and income, you may not receive all the 5%. A higher-rate taxpayer only receives £60 for every £100 in interest being paid. So, in this specific example, the 5% rate after tax only pays 3%. However, it is important to remember that investments are also subject to tax. Depending on your tax position and income, you may not receive all of the positive performance reported after tax.
This State of Play weekly update has in previous editions spelled out the reasons why people choose to invest, primarily driven by a desire to achieve returns in excess of inflation by accessing the returns available from bonds, shares, property, and other alternative asset classes. Clearly, any investment, depending on what assets you choose, will vary in value and experience volatility where the value goes down as well as up, with no guarantees.
The power of diversification and long-term investing
Source: Bloomberg Barclays, FTSE, J.P. Morgan Economic Research, MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. Annualised return and volatility covers the period from 2013 to 2022. Vol. is the standard deviation of annual returns. Govt bonds: Bloomberg Barclays Global Aggregate Government Treasuries; HY bonds: ICE BofA Global High Yield; EMD: J.P. Morgan EMBI Global Diversified; IG bonds: Bloomberg Barclays Global Aggregate – Corporates; Cmdty: Bloomberg Commodity; REITs: FTSE NAREIT All REITS; DM equities: MSCI World; EM equities: MSCI EM; Hedge funds: HFRI Global Hedge Fund Index; Cash: JP Morgan Cash United Kingdom (3M).
Asset class returns can significantly change year on year, as seen in this multi-year asset class return table above. As an example, in 2017, Emerging Market shares returned 25.8%, the highest-performing asset class. In 2018, the following year, Emerging Market shares returned -8.9% and were the lowest-performing asset class. Being exposed to too much of any single asset class can add volatility to an investment portfolio. Incidentally, cash provided the lowest annualised return over the last 10 years, although this was during an extreme period where interest rates were kept at near zero by policymakers. The key lesson from this ‘asset class blanket’ is that investing in a well-diversified investment portfolio aligned to your risk comfort and time horizon can help reduce volatility and potentially increase your chances of achieving your long-term financial ambitions. Past performance is no guide to future performance. Investments can go down as well as up. You may not get back the amount you invested.
How have UK shares performed versus cash over the longer term?
The chart below shows the long-term returns for cash when compared to UK shares and UK bonds between 1998 and June 2023. These returns have been lowered to show the effects of inflation over the same time period. More recently, as I have highlighted earlier, cash has become more attractive with higher rates. However, rates are expected to reduce in the next few years as inflation returns back down to the central bank’s target of 2%.7 If the past is anything to go by, cash tends to offer much lower long-term returns when compared to investments, especially when you factor in both inflation and taxation impacts. Obviously, the caveats are that the past is no guide to future events, as the last few years have demonstrated graphically.
Total return of £1 in real term
Time in the market, not timing, matters most
One important lesson about investing is that it is about time in the markets rather than trying to ‘time’ when you invest. Many investors can become nervous as they approach the point at which they invest, hoping to pick the optimum moment. However, while timing your decision to invest can have a positive impact, it is almost impossible to get it right unless you have the benefit of hindsight. Delaying a decision to invest until you feel it is the right time can reduce your returns considerably, or worse still, staying in cash may be worse over the long-term. The chart on the left shows the outcome of investing since 2010, which, regardless of market and economic conditions, even if you picked a bad time, is much better than staying in cash. Importantly, investing immediately is not far below benefiting from luck and investing at the perfect time. The chart on the right shows the impact of missing the top 50 days in the S&P500 (US shares). Even if you miss just the top 5 days, the reduced returns compared to staying invested are significant.
Investing is time, patience and importantly, persistance
Investing is almost always an emotional journey, especially for first-time investors who take advice and commit for the first time to a longer-term financial plan that includes investing. One of the key principles of investing, arguably for most people, is investing for an appropriate period of time. While history may not repeat itself, if you look back over very long time periods, the longer you are prepared to invest, the narrower your outcomes are likely to be and the less chance you have of losing either some or all of your capital. The chart below illustrates this very well.
The chart shows historical returns over various holding periods for US Equities, US Bonds and a 50/50 even split portfolio of the two.
The bars show the highest and lowest return that you could have received during each of the time periods.
The benefit to investors of remaining invested over the longer term, regardless of whether an investor held US shares, US bonds or a balanced portfolio over the 20-year rolling period, all provided positive returns with lower volatility.
Source: Bloomberg Barclays, Refinitiv Datastream, S&P Global, Strategas/Ibbotson, J.P. Morgan Asset Management. Large cap equity represents the S&P 500 Composite and Bonds represents the Strategas/Ibbotson US Government Bond Index, the US Long-term Corporate Bond Index until 2000 and the Bloomberg Barclays US Agg. Corporate – Investment Grade Index from 2000 onwards. Returns shown are per annum and are calculated based on monthly returns from 1950 to latest available and include dividends. Past performance is not a reliable indicator of current and future results. Guide to the Markets - UK. Data as of 30 June 2023.
Past performance is not a guide to future performance. Investments can go down as well as up. You may not get back the amount you invested.
The strength of human emotions has been covered extensively in previous State of Play editions, which explored our natural human biases, which in many respects can hinder our decision-making when investment markets become very volatile or financial uncertainty dominates the headlines. If you look back over history and directly plot key events that triggered significant falls in investment market values and chart the returns of an investor who chose to sell their investments when compared to those who remained invested, it is, in my humble opinion, quite extraordinary. The chart below highlights the key events since 1989, based on an initial investment of £10,000, and shows the values as at, the end of last month (August 2023) comparing the values against each of these trigger points. The £10,000 of the investors who didn’t sell is today worth £135,429.79, when compared to the investor who sold when the tech bubble burst in 2002 and went into cash, their savings are worth only £27,997.77. Even if you held your nerve and sold at the start of the global pandemic, just over three years ago, the difference between selling and remaining invested is around £50,000. The other important measure on the chart is inflation. As you can see, in order to keep pace with rising prices, your original £10,000 investment has to have grown to just above £25,000 to achieve any 'real' long-term growth.
£10,000 invested in the stock market in 31st December 1989
At this point in the typical cycles of investing, with cash rates now offering competitive returns, at least in the short-term, savers and investors understandably might question the principle of investing. However, while the normalisation of interest rates has significantly improved the options available, depending on your specific personal financial circumstances, the reason why people may be motivated to invest has, in my opinion, hasn’t changed. In previous editions, I have explained that any investment decision needs to be based on your financial ambitions, your time horizon and your risk comfort. Arguably, all financial plans over long time periods of over five years would typically incorporate a balance between savings and investments. At present, the proportion you may allocate to savings to capture the competitive rates available right now may be higher than, say, three years ago, but history shows that relying on cash rates to achieve our goals can prove to be foolish. It will be interesting to observe, if some believe that cash is indeed King at present, how long will the reign last?
The value of seeking guidance and advice
It is important to seek advice and guidance from a professional financial adviser who can help to explain how to build an appropriate financial plan to match your time horizons, financial ambitions, and risk comfort. If you already have a plan in place, or have already invested, it is important to allocate time to review this to ensure this remains on track and appropriate for your needs.
10-year bond yieldsCurrencies
Note: Data as at 7 September 2023. 1Bank of England, 9 August 2023. 2The Guardian, 7 May 1997. 3National Savings & Investments (NSI), 6 September 2023. 4Money Saving Expert, 6 September 2023 5 Santander, 6 September 2023. 6Money Saving Expert, 9 May 2023. 7Bank of England, 3 August 2023.
For retail distribution.
This document has been approved and issued by Santander Asset Management UK Limited (SAM UK). This document is for information purposes only and does not constitute an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Opinions expressed within this document, if any, are current opinions as of the date stated and do not constitute investment or any other advice; the views are subject to change and do not necessarily reflect the views of Santander Asset Management as a whole or any part thereof. While we try and take every care over the information in this document, we cannot accept any responsibility for mistakes and missing information that may be presented.
The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Past performance is not a guide to future performance.
All information is sourced, issued, and approved by Santander Asset Management UK Limited (Company Registration No. SC106669). Registered in Scotland at 287 St Vincent Street, Glasgow G2 5NB, United Kingdom. Authorised and regulated by the FCA. FCA registered number 122491. You can check this on the Financial Services Register by visiting the FCA’s website www.fca.org.uk/register.
Santander and the flame logo are registered trademarks.www.santanderassetmanagement.co.uk