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Interest rates are up: Is Cash now King? 

January 10, 2024

To stick or twist; to be cautious and cash-in or keep the money on the table.  These are gamblers’ choices; ones that as investors we occasionally feel an irrational pull toward making, and as a ‘proper’ Chartered Financial Planner, I strongly counsel against.

There are many psychological and behavioural traps to avoid when investing, and plenty of research on the topic that I won’t reference here. To be brief, I’ll just spotlight the relativity trap – where someone’s view of their own situation inappropriately influences your behaviour in your own dissimilar situation.  Just because your friend has switched their investment portfolio to cash and is feeling smug about a 5% + return (how long will that last?), it doesn’t mean that it’s the right thing for you.

In this piece, I’ll share my views on the hazards of confronting a bad “stick or twist” choice between cash savings and investments and provide some tips to cut through the short-term noise while staying focussed on your longer-term goals.

The backdrop: We have witnessed 3 years of extreme stock and bond market volatility driven by well-documented global events. The period of record low (and at times zero) interest rates has been followed by a significant spike in inflation globally and a subsequent rapid rise in interest rates. Central bank base rates are now at a level last reached in February 2008, and have risen at a velocity not witnessed since the period May 1988 to October 1989, when the UK Bank of England base rate soared from 7.38% to 14.88% in 17 months.  Just let those last numbers sink in if you weren’t exposed to a mortgage in those days – if you were, then you probably still bear the scars.

The conundrum: With interest rates north of 5% and unlikely to fall rapidly soon, and with investment performance charts resembling an angry set of shark’s teeth, is it time for a switch from investments to cash and to try to capture some of this apparently risk-free high interest bonanza?   Many private and institutional investors seem to think so with many investment funds now having seen over a year of significant redemptions. 

Whilst the large Institutions have teams of professionals scouring global data for leading economic indicators on which to base their decisions, they are still playing a risky game of chance – trying to time both the exit and re-entry between asset classes to their advantage.  We don’t like the odds of this game; professional traders may have to trade, and gamblers may do just that by choice, but we passionately advise against playing a game where the odds are so strongly stacked against you.

Indeed, October was the highest month of redemption to cash in this cycle, just days before the start of a ‘Christmas rally’ in stocks and bonds that saw growth of over 10% in portfolios over the last two months of 2024 after a negative 10 months until then.  If the largest professional institutions can’t get this timing right, then what hope the rest of us?

What if there’s another Recession? Recessions (defined as a fall in GDP for 2 successive quarters) sound like a worrying time for investors, so shouldn’t I just avoid investing at these times?” I hear you ask. A rational question and I’ll attempt to ease your worries here with some help with data from Capital Group, a US investment manager who state that since 1950, the US has seen 11 recessions, on average lasting around 10 months, whereas the economic growth periods last nearly 70 months on average.  Equity markets are forward looking and typically peak around 10 months ahead of the economic cycle summit. Equally they begin to rally on average around 10 months before the recession ends.  In short, trying to time any of this to your advantage (sell the recession, buy the rally) is a gamble to avoid, with the odds once again weighted steeply against you.  

I refer to, and always advocate the longer-term perspective supported by the fact that economic growth periods have tended to outrun recessions on average by a factor of 6 X in length and 10 X in scale (with the covid pandemic impact being the clear contrary outlier in 70 years of data).

The often-quoted mantra of time in, not timing markets is as true now as it ever was.

The returns on cash still look attractive, will that last?  The rise in interest rates was inevitable after years of additional money supply from central banks and near-zero interest rates.  The recent burst of high inflation resulting mainly from the pandemic and Russia’s invasion of Ukraine has forced central banks to raise rates to try and slow down the impact of inflation. 

It is an imperfect equation but goes something like this:  higher rates => lower spending => business reduce prices of goods/services => reduction in inflation.  If only it were that simple! With global supply chains clogged and conflict continuing, inflation has been slow to fall but is doing so now and some economists are predicting interest rates may start to reduce this year.  Of course, some economists will always be right and others wrong and we don’t do prediction at Walden Capital.

We are back to our time in vs timing bellwether, so let me unpack this a little more with some tips.

Tip 1:  Remember why we invest:  To protect and grow the “real spending power” of the capital you have for the future.  We know inflation will erode that value; given time.  Cash rates may lessen the impact in the short term, but over the longer term (say 10 years plus) a combination of stocks and bonds at various levels have historically provided potential for significant returns beyond inflation.  Of course, volatility impacts a risk based portfolio, and should not be ignored, but there is no free lunch – and over a term longer than 10 years balanced portfolios have out preformed cash in the vast majority of recorded periods.

Tip 2: Have some Buckets:  It is a good idea to have distinct pots of capital for different goals over different time frames.   If you have a short-term goal (say less than 5 years) for a slice of your money, then finding the best cash rate now will give you certainty, and the risk of the stock market is almost certainly not right for that ‘bucket’.  If you are looking at a longer-term goal, say 15 years or so, then cash will probably lag inflation and will see your spending power reduced. Cash is not a risk-free option as over time you’ll be able to buy less with it.

Tip 3: Build a plan based on your goals and lifestyle:  Having a complete picture of your goals, lifestyle aspirations, assets and liabilities provides you with clarity and confidence in your finances.  You’ll know what’s in your cash bucket and why, and the same for your investments, pensions and other assets.  As financial planners at Walden Capital, this is what our clients want from us – getting to know them well and working with them to build a lifestyle cashflow model which becomes the anchor point from which their financial goals can be achieved. The visual nature of the plan has a positive well-being impact on our clients – often commenting on how positive they feel about the clarity of their plan and the freedom it gives them from worrying unnecessarily.  They can avoid the “noise” and are less susceptible to falling into the many behavioural traps (and potential costly mistakes) referenced earlier.

I’ll finish by returning to the question: is cash now king?  The answer is the same as it ever was.  Cash is king for the short term, but not for the long term, and that is as true today, as it was in 2020 with rates at 0.1% or in 1989 at 14.88%.  Cash is king if you’re going to spend it soon, otherwise not.  Staying in cash for the long term will almost certainly see destruction in the value of your asset.

If you’d like help with your own plans or want to find out more about how Walden Capital work with clients, then get in touch.

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