In today’s economic climate, investors must exercise caution when evaluating headline deposit rates. While a 5% return on cash deposits may initially appear enticing, it is essential to grasp the impact of inflation. This blog post explores why a seemingly attractive cash rate can result in a negative real return. It explains why many investors may be better off maintaining a traditional balanced investment portfolio.
The Reality of Inflation:
When considering deposit rates, it is important to understand the impact of inflation on the value of money. The UK’s Consumer Price Index (CPI) inflation rate currently stands at 8.7%. This means that any investment returning less than 8.7% will lead to a negative real return, gradually eroding the purchasing power of money over time.
Negative Real Return:
Despite the headline deposit rate of 5%, it is crucial to acknowledge the negative real return associated with cash deposits. With current inflation of 8.7% surpassing the deposit rate, investors face a real loss of c3.7% annually unless inflation falls. Over time, this can significantly impact your financial goals and long-term prosperity.
The Historical Perspective:
Let us examine the historical average return of cash deposits to gain a broader understanding. According to JP Morgan’s Guide to the Markets Q2 2023, the real return of cash deposits has averaged 0.6% per annum from 1900 to 2022. This historical data highlights that cash deposits are not an attractive long-term investment option when considering inflation and wealth preservation. It also illustrates that the current negative real rate, i.e., minus 3.7%, is far from attractive compared to long-term average cash deposit rates.
The Power of Balanced Investment Portfolios:
In contrast to cash, a traditional balanced investment portfolio offers the potential for higher returns over the long term. These portfolios typically comprise a mix of asset classes, such as stocks, bonds, and other investment vehicles. While investments may experience short-term volatility, they have historically outperformed cash over extended periods.
Diversification and Risk Management:
One of the key advantages of a balanced investment portfolio is diversification. By spreading investments across different asset classes and sectors, investors can mitigate risk and optimize returns. Collaborating with a professional financial advisor can help tailor portfolios to align with individual risk tolerance and investment objectives.
Investments should be approached with a long-term perspective rather than solely focusing on short-term gains. Adopting a long-term outlook enables investors to navigate market fluctuations and benefit from the growth potential of their portfolios. While cash may seem appealing in the short term, it often falls short of providing the necessary returns to combat inflation and achieve long-term financial goals.
The Power of Balanced Portfolios: A Case Study:
For instance, over the last ten years, a balanced investment portfolio could have delivered an average return of 7%, compared to a meagre 0.5% return on cash (Source: JP Morgan’s Guide to the Markets Q2 2023). This example demonstrates the potential disparity between cash and balanced portfolios when considering longer investment horizons.
Of course, given the challenging last eighteen months or so, it’s not surprising that many investors, especially less experienced ones, are considering throwing in the towel and switching back to the supposed safety of deposit. However, with cash currently delivering a 3.7% per annum real loss, does cash really offer you safety? It’s important not to confuse the certainty of cash with safety.
Headline deposit rates can be deceptive, particularly when inflation surpasses the returns offered. Investors must exercise caution and consider the negative real return currently on cash deposits. Sticking with a traditional balanced investment portfolio, customised to individual risk profiles, offers the potential for better long-term returns and wealth preservation, albeit with the risks of capital loss. Remember, seeking guidance from a professional financial adviser is vital when making investment decisions tailored to specific goals and risk tolerance.