3 days ago
Don't be duped by Reeves's Isa reprieve – get your money out of cash now
Banks and building societies are thrilled that Rachel Reeves has temporarily shelved plans to cut cash Isa allowances. But that doesn't mean you should top up cash holdings.
Whatever eventually happens with allowances, holding too much cash is a real and big risk called 'opportunity cost'.
Forget the politics here, and whether Reeves's goal – getting more money into stocks and shares Isas to boost investment and returns – would work. This is all about your needs and whether your finances will meet them.
Tax allowances aren't solely why Britons hold nearly £300bn in cash Isas. It's because cash feels safe. It doesn't swing short-term like stocks and sometimes gilts. But cash quietly hampers long-term returns, risking a brutal, underfunded retirement poverty.
Few investors fully fathom this. Here's how you should balance your portfolio.
Holding some cash, maybe six to 12 months' expenses, is sensible as an emergency fund. It can help you invest better by avoiding forced securities sales at inopportune times. Or, if you have a home purchase or other major expense in the next few years, setting cash aside is wise.
But if that's not the case? Cap your cash.
Numerous studies show that asset allocation – your mix of stocks, bonds, cash and other securities – determines most of your long-term return. Not market timing. Not stock picking. Not perceptions of 'safety'. Asset allocation dominates.
Your goals, needs and time horizon should largely determine your allocation. The longer your time horizon and the more growth you need, the more you need long-term in high-returning stocks. Maybe those who need income or who can't stomach volatility hold some bonds. But cash? Keep it minimal.
Why? Minimal returns. Over the past century the FTSE All-Share index annualised 10.1pc through to 2024. Gold? 7.7pc. Ten-year gilts? 5.2pc. Cash? Short-term government bills (a cash proxy) returned the lowest, just 4.7pc a year since 1924. It's been even lower since 2000 at 2.4pc.
Meanwhile, over the past century, inflation has averaged 4.3pc, eroding your returns. Since 2000 inflation has averaged 2.5pc, devouring cash returns entirely. If your goals require any real returns, cash is unlikely to deliver it.
So, how much cash do you hold? What is your asset allocation? Too few investors know.
Start thinking about asset class. Total up what you hold in all your accounts, any current account, savings account, pensions or Isa. Stocks, tracker funds, all of it. If you own funds that blend stocks and bonds, calculate it this way: if you have £100,000 in a 60pc stock, 40pc bond fund, chalk £60,000 to stocks, £40,000 to bonds.
Then subtract funds earmarked for known, near-term expenses or emergencies. Once you have that total, divide each category – stocks, bonds, cash and other – by the total. The resulting percentages are your allocation. Now what share is your cash?
Consciously or not, your allocation reveals an implied forecast. If you hold piles of cash, you imply history's lowest-returning asset class is more future-fit than historically higher-returning ones, like stocks. In other words, if you're holding lots of cash you are implicitly being mega-bearish.
That is a huge risk, maybe the biggest one you can take if you need growth to finance your goals. If it is intentional, you must see big negatives others don't (that markets haven't priced in) to justify it.
Many say they hold cash 'in case' stocks tumble. But at what cost? The best buy-the-dip opportunities, like early April 2022 or Covid's 2020 crash, come with huge fear. Precious few seize them. Did you? Your 'dry powder' turns into a long-term drag.
The truth is, big cash holdings feel good but they hurt overall returns.
Since 2000 (a cyclical stock market peak), £1m invested in 70pc London-listed stocks and 30pc long-term gilts grew by £2m through 2024. Stash even 20pc in cash, and you wound up with £233,351 less. And that is despite a big, multi-year bear market starting that stretch. If you had invested globally, that gap would be far wider.
You may say, 'but that is over 25 years!'. Surely shorter horizons bring many more periods when stocks sink, right?
But consider this. Since 1924, using monthly returns, the FTSE All-Share rose in 75pc of rolling 12-month periods. Not bad! It climbed in 91pc of rolling five-year periods – even better. No rolling periods greater than 10 years were negative. Not one.
Moreover, while even rising deposit rates can't make cash beat inflation, stocks can and do.
UK stocks averaged 73pc over those five-year rolling periods and 215pc over the rolling 10-year stretches. Similar patterns hold for global stocks.
Don't get duped by cash's supposed safety. Think total holdings and asset allocation – and cut your cash to the core.
