The "erosion" of cash - a myth?

free4440273

zelda2007 wrote: »

I wonder if someone can help put this straight. I've noticed a few posts saying that investing money in cash (i.e. bank accounts) is a bad long-term idea and will actually "erode" it's value. For example Dunstohh (not singling you out, you just happened to have written the last post I saw on this issue) pretty much said that long-term investments of cash are a big no-no.
Maybe I am wrong here, but this just isn't true. If carefully and gradually saved in carefully selected accounts, cash will not erode in value and in fact can (very small) increase in value over time. For example, transferring the money into ISA's and accounts that always (after tax) pay interest higher than inflation. Now obviously if you acquired a £500,000 lump sum all at once, if all invested in cash it would definitely be a bad idea. But gradually saving a few thousand pounds a year and building up a nest-egg in high-interest account(s) will not erode the value. I am aware investing in the stock market is usually better long-term but feel that a financial advisor effectively telling people to "rule out" cash, is mis-leading and not correct.

Or maybe I'm just getting it wrong???

i am no expert but i actually agree with the gist of what you are saying; have always thought so but never had the 'guts' to say so on this forum. however, mathematically speaking - and this is in their defence - is what some of the posters here have been saying, and in that regard they would probably be right. generally, i think pure cash-only investments are safe, sound and - if you play your cards right (rate of interest, level of investment, duration of investment = higher rate of interest, often) - offer at least some return. but, i'm no expert...

ManAtHome

Nothing wrong with cash ISAs, possibly even NS&I tax-free investments as PART of your planning. Cash in taxable savings accounts is a bit of a balance between returns and flexibility.

As an example, IceSave currently pays 5.7% gross which is 4.56% after savings tax, 3.42% if you're a higher-rate taxpayer. As CC said, depends on your own inflation as to whether these will show an increase or not.

Contrary to popular opinion (outside MSE of course... sometimes), putting all your eggs in one basket (sh*t or bust investing) is not the best idea over the long term...

debbie42

I'd be interested to see figures that suggest that had I invested my cash in the best savings accounts, it would have kept pace with inflation over the past ten or twenty years.

No one can predict the future, but I'm comfortable with a balanced portfolio of investments and savings. I do think one particular quote has been taken out of context and very much doubt that cash in Building Societies and Banks could possibly always (and consistently) beat the market, or those institutions would not be making much of a profit on everyone else's investments. :rolleyes:

dunstonh

According to moneyfacts:
the Average no notice / instant access savings rate is 3.65% (£5K)
Average notice savings rate is 3.795% (£5K)
25% of no notice accounts pay rates below 3.10%, the CPI figure, while a staggering 69% pay less than 4.80% - RPI.
17% of no notice accounts pay rates equal to or greater than 5.25% - Bank Base Rate

source: http://www.godirect.co.uk/news/25-04-2007.php

HBOS data in 2005:

Savings through the decades:

1960’s

· The best year for savers during the 1960's was 1967 when the real rate of return was +3.7%. The worst year during the 1960's was 1962 when the real rate of return was +0.7%.
· Building societies had a clear run in the retail savings market during the Swinging Sixties. In 1960 there were just under four million building society savings accounts. By 1970 that had risen to over 10 million.
· The money invested in building societies more than trebled during the 1960s, from £2.9 million in 1960 to over £10 million by 1970.
· There was very little competition among societies themselves on savings interest rates. A ‘cartel of societies’ agreed what the mortgage rate would be – the recommended rate system – and savings rates followed.
· Well over 90% of all building society savings were still held in ordinary share accounts.

1970’s

· Raging inflation in the mid-1970s meant this was the worst decade for savers who enjoyed positive “real” returns for only two out of ten years (1970 at +0.8% and 1978 at +0.2%)
· Savers saw their worst return in 1975 when the figure was minus 14.1%.
· Building societies continued to dominate the savings market. Their share of personal savings climbed from under 20% at the beginning of the 1960s to well over 40% by the end of the 1970s.
· In 1973 a new type of building society savings account - term shares - were introduced. Term shares guaranteed to pay an extra interest differential over ordinary accounts, typically for two years. They accounted for only 10% of society accounts in 1978, but more than 20% by the end of the decade.
· Most savers benefited from the building societies system of deducting a “composite” rate of tax from savings interest. This took off an amount based on the average tax liability of all society savers. The composite rate was much lower than the basic rate – the problem was that savers who did not pay income tax couldn’t claim this 'composite' rate back.

1980’s

· The best year for savers during the 1980's was 1986 when the real rate of return was +7.5%. The worst year during the 1980's was in 1980 when the real rate of return was minus 4.8%.
· Increased competition from the banks meant that there was more competition in the personal savings market.
· Smaller and foreign banks launched savings and banking accounts for customers. The introduction of cash machines – known as Automated Teller Machines (ATM’s), made it cheap and easy to deliver the new style accounts.
· Building societies started to offer notice accounts where savers earned a higher rate of interest for giving 28 days notice that they wanted to take money out. The notice period was soon cut to only seven days.
· Increased competition from banks and National Savings led to the collapse of the Building Societies cartel in October 1983. The old “gentleman’s agreement” system of setting mortgage and savings rates was replaced by cut-throat competition.
· The 1980’s saw the launch of tax-free Personal Equity Plans. These were followed in 1987 by free standing Additional Voluntary Contributions for people in company pensions and in 1988 by Personal Pensions.
· Some £15 billion of savers’ money was diverted from savings accounts to pay for shares in big privatisation issues like British Gas in the late 1980s.
1990’s

· The best year for savers during the 1990's was 1991 when the real rate of return was +3.8%. The worst year during the 1990's was 1995 when the real rate of return was +1.8%.
· Savings accounts operated by telephone and post started to appear in the early 1990’s.
· In April 1991 TESSAs were introduced – the five year Tax Exempt Special Savings Accounts.
· Also in April 1991 composite rate of tax was abolished, following the introduction in 1990 of independent taxation for husbands and wives. For the first time married women could have a nest egg of their own and receive equal tax treatment. Children and other non-taxpayers could now register with banks and building societies to have their savings interest paid gross.
· In 1995, Tory Chancellor Kenneth Clarke’s third Budget extended the 20% lower tax rate to almost all savings income. Savers liable to pay tax at the basic rate of 25% did not have to pay any more tax on their savings interest.
· In 1997 the Halifax, previously the world’s biggest building society, converted into a public limited company and issued shares to 7.6 million of its members. Other former building societies, Alliance & Leicester, Woolwich and Northern Rock also converted during 1997 and the shift of power in the savings market moved from building societies to banks.
· Labour’s first Budget in July 1997 unveiled the new tax-free Individual Savings Account – ISA – which would replace PEPs and TESSAs in 1999.
· In 1998 savings accounts operated over the internet began to appear.
· The 1999 Budget saw a new 10p lower rate of income tax. This initially applied only to the first £1,500 of earnings and pension income, but was extended to savings (and backdated to the start of the tax year) in November 1999.

oldfella

my view is if you keep your money in savings accounts and dont spend the income then you will be marginally ahead after inflation

if you keep your money in the market then in the long term you will be comfortably ahead of inflation

Xbigman

The biggest factor not yet really mentioned is that of scale.

If you have smallish sums to save, up to about 3500 a year, then you can cherry pick the best ISA's and regular savings accounts available and make a small gain over inflation at the moment. Below 3500 is also where the charges on a lot of investments are not an insignificant cost.
Once you go much over 3500 the tax you now have to pay combined with inflation makes cash look increasingly sedate.

For the small saver who has little to lose but values that little, cash is king. For anyone else cash is just not good enough.
Regards


X

plonkee

It is often (but not always) possible for cash to keep up with inflation. Strictly speaking you only need to have your cash in an account that pays out interest at a higher rate than inflation after taking tax into account.

If you want to do this whilst taking a significant income you are likely to find it extremely difficult even if you have a huge sum of money.

I'm guessing that the biggest reason that cash is not suggested as a good home for money that needs to provide an investment is that people often / always forget about inflation risk. In actual fact keeping large sums of money is riskier than is commonly believed. Whereas it wouldn't surprise me if the stock market was less risky than many people believe - particularly as you can develop a portfolio to suit your risk level.

tomstickland

Maybe I am wrong here, but this just isn't true. If carefully and gradually saved in carefully selected accounts, cash will not erode in value and in fact can (very small) increase in value over time. For example, transferring the money into ISA's and accounts that always (after tax) pay interest higher than inflation.

Well, obviously! If the rate of interest exceeds inflation at all times then you will be gaining ground. After that it's just a matter of finding the best rates and deciding what your true inflation is.
Most cash accounts will trail inflation, and if income is also required, then it's even worse. Investment funds carry more risk, but higher returns and on average outstrip cash savings.

jamesd

So, you're a small player and you cherry-pick. You make 6.1% in a cash ISA and inflation is at 4.8%. You end up with 1.3%. Now, equities have historically returned about 4.2% more than cash, so you could get 5.5 in equities.

An after inflation gain that is four times the one from cash looks interesting to me.

Secret_Wookie

Don't forget that everyone has their own personal rate of inflation depending on your personal lifestyle.

http://www.statistics.gov.uk/PIC/index.html

The RPI is trying to be as representative as possible but depending on your own personal buying habits it maybe higher or lower for you as an individual.

http://www.statistics.gov.uk/elmr/04_07/downloads/ELMR_April07_Wingfield.pdf