When we look at risk we have this fixation that cash is the lowest possible risk asset. It is a simple assumption, you have £100,000 and assuming the bank doesn’t go bust you will have £100,000 at the end ignoring any interest. Seems a simple assumption, if you put £100,000 in the stock market you don’t know what your end result will be. So risk in these terms would put cash at the bottom of the tree.
Unfortunately this is the position of the regulators and journalists, in reality they are missing one of greatest risk assets ever……..
The chancellor would like inflation to sit around 2%, the only way to do this would be to increase interest rates. Although our economy is in a stronger position it is still fragile and a sudden increase in interest rates would effectively kill any potential growth that is currently flickering into life.
We saw in June that inflation increased to 2.7%, this is bad news for those who continue to hold money in cash. Interest rates are poor and it is becoming harder to achieve anything above 1%. This means effectively that savers are losing money.
Where savings were used to provide income, clearly a rate of 1% on £100,000 will only provide an income of £1,000 a year with no growth on the capital. With current life expectancy greater nowadays those using cash to fund income have a double hit of no growth in their capital, therefore falling in value in real terms - but also a drop in income year by year in real terms.
It causes me concern that journalists and regulatory bodies insist that cash sits at the bottom of the risk scale, when in reality although there is no loss of capital: i.e. £100,000 will be £100,000 in 20 years’ time, in real terms inflation will kill this investment.
Consider £1000 of income assuming the 1% remains constant will be worth around £580 in real terms after 20 years assuming inflation of 2.7%. Equally assuming no growth on the £100,000 this would be worth around £58,000. The ‘purchasing power’ of that £ is greatly reduced – even if the balance doesn’t change.
In real terms a tank of petrol in twenty years’ time will cost £160, today it is around £93. A bottle of wine today is around £4.71, in twenty years it will be £8.13 and so we can go on.
The point is that rising inflation will kill cash and until regulatory bodies accept this we have a problem.
So what can be done?
I have said before if you have only a small amount of savings then very little, but there are options.
If £100,000 was invested in a diversified portfolio within a tax free environment and this returned 5% after charges the value of this in real terms would be around £158,000. Consider this against cash and the difference in real terms is around £100,000.
Of course the big difference is volatility the money in cash remains constant but the money in equities will fluctuate.
When defining risk we need to consider this new world, otherwise there will be many disappointed savers. I appreciate this is hard when the regulators cannot see this but it is something that people should be made aware of before it is too late.