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Why cash may not be NISA

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30/06/2014
The new ISAs (NISAs) launch tomorrow with many hoping they will herald a new era of saving. However, investors will also have to shake off their preference for cash.
Why cash may not be NISA

While many more people are saving, relatively few are convinced of the merits of putting money into stock or bond markets. Around 80 per cent of ISA investment still goes into cash ISAs, according to HMRC. The recent BlackRock Global Investor Pulse Survey found that young women aged 25 to 34 have more than 80 per cent of their savings and investments in cash, the highest proportion of all age groups, and only 13 per cent describe themselves as ‘actively investing’ .

On the face of it, a high allocation to cash is a rational choice in the current market environment. The FTSE 100 is at five-year highs, suggesting stock markets are no longer cheap. Bond markets look even more expensive, having had an almost uninterrupted bull market for more than a decade. Investors are rightly nervous that any sell-off may be painful and prolonged if the economic environment turns.

Equally, while the UK is currently basking in a recent run of buoyant economic news, risks still remain. There has been no meaningful dent in the UK’s debt burden. The UK’s major trading partners – the US and Europe – also have similar problems. Future growth is not assured and therefore cash can look like a safer option.

A number of expert investors agree. Recent research by Financial Express showed that two of the Schroders multi-manager funds – MM Diversity Tactical and Schroder Multi-Manager High Alpha – are holding 44% and 38% in cash, or quasi-cash respectively. Overall, eight funds in the IMA flexible sector were holding more than 10% in cash.

However, one swallow does not make a summer, and although some multi-managers feel strongly that cash is ‘safer’ than any other option at the moment, the view is not universally held. Certainly, investing money in stock or bond markets is more difficult in the current conditions than it was as recently as 12 months ago, but it doesn’t mean there aren’t places to invest, or that investors shouldn’t strive to find them.

The trouble is that cash is not a long-term option. Advisers tend to recommend that everyone holds a ‘buffer’ of around three months spending in cash, but retaining all savings in cash runs the risk of significant erosion by inflation over time. At the moment, UK inflation is relatively benign – CPI inflation was 1.5 per cent in May of this year – but many expect this will rise. The most recent YouGov poll showed Britons expected inflation of 2.1 per cent over the next 12 months and 3-3.15 per cent for the next five to 10 years. According to Which, the highest paying 1-year fixed cash Isa (Virgin Money) pays just 1.76%. This means savers risk losing over 1% a year over the long term from the real value of their wealth.

In an ideal world, investors would raise and lower their cash weighting in line with their expectations of the rise or fall in markets, but it is notoriously difficult to predict the right and wrong time to invest. The greatest investment minds have frequently failed to predict the ebb and flow of markets and move in or out at the right time.

This sounds like a catch-22. Stock and bond markets are expensive, but cash will erode purchasing power over time. The answer is not exciting, but does bear long-term analysis: Drip-feeding money into markets, by regular savings or staggered lump-sum investing, gets round many of these problems and is probably the ideal solution for an investor still nervous about branching out from cash.

Ultimately, cash is not a long-term solution for wealth generation. Savers need to move away from an exclusive reliance on savings accounts to fund their future. Potential investors need only take baby steps.

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