People naturally tend to think that cash is a safer bet. After all, for much of the past thirty years, banks paid an interest rate above the rate of inflation, meaning savers could put their money away knowing that it would steadily increase in value over time.
Over the past decade, however, cash in the bank has delivered a negative return in real terms (i.e. when you take into account the effect of inflation). Record low interest rates, combined with persistent inflation, have meant that the real value of cash in a savings account has fallen over the past ten years – as shown in chart below.
The mistake people make when thinking about cash savings is to ignore the impact of inflation. Even a relatively modest inflation rate of 2% (what the Bank of England targets) means that your money loses a third of its purchasing power over twenty years.
People also tend to favour the apparent safety of cash over the perceived risks of investing – ‘I can lose money when investing, so I will stick with cash’. While the immediate risk of investing may seem off-putting to some, this has to be set against the longer term risk of cash savings being eroded by inflation. This is the opposite to investing, where the longer you invest, the lower your risk of negative returns is, and the better your chances of outpacing inflation.
To see how investors beat cash savers over long timeframes, we compared cash savings and investment returns over the past ten years. Chart 2 shows the nominal (i.e. before the effects of inflation are taken into account) return of cash in a bank account, UK government bonds and UK equities over ten years to the end of 2018.