When cash was king

cash

I promised my twitter followers something special:

So here it goes. It’s 1 January 1989, the Soviet Union still exists, Kylie Minogue has just conquered the charts with her debut album and Young FI Guy isn’t even born yet. Here’s the question: what would you take: 20 years of cash returns or 20 years of global equity returns. A no-brainer right?

Cash vs ACWI - 1989 to 2009

Quite remarkably the return on both was almost exactly the same (although with significantly different journeys!). Two months later, in February 2009, the cash return would overtake the equity return. That’s right, over a twenty year period, cash beat equities.1

What the hell?!

Financial economics says this shouldn’t happen. Over such a long period, higher risk assets should deliver higher returns. But it can happen. As Monevator recently pointed out: Taking more risk does not guarantee more reward. That’s because:

Risk means that more things can happen than will happen.

When cash was king

It’s easy to forget, but cash used to give a pretty great return:

Throughout the 90s and early 00s, cash paid out significant real returns. And we’re talking risk-free returns here. The return shown above is from the Building Society Association. This is the average interest rate you’d get from popping to your local building society and opening a savings account. No TIPS ladders, no money market shenanigans. Simple deposit savings. Completely risk and stress-free.2

Mr YFG’s journey – growing a princely sum

This result, though surprising, was instinctive for me. I grew up saving a lot. By the time I was 16 I had saved up 1,000s of pounds through birthday and Christmas gifts and working. I fondly remember double-digit interest rates up until the late-00s. Children’s accounts could have incredibly high rates. I very much rode that cash returns chart. But then the financial crisis hit.

Knocked off the throne

I suspect some of you will be screaming at your screens right now: “you’re not telling the whole story!”

Alas, you are right. Because since the financial crisis, interest rates have plummeted:

[Note: the BSA average Building Society rate data stopped in 2007, to create a longer dataset, I’ve combined this with the Bank of England average 1 year Fixed Bond interest rate from 2008.]3

I’m not a banking expert, but from what I gather there are three reasons why this happened:

  1. Quantitative Easing and Funding for Lending – these policies made it very cheap for financial institutions to borrow money. It dramatically reduced the need for customer deposits to fund lending.
  2. In addition, the Bank of England drastically cut the base rate, further reducing the cost of borrowing.
  3. The financial crisis caused a wave of consolidation in the market, reducing the competition for customer deposits.

This had a huge impact on returns:

Generally speaking, real cash returns have been negative since the financial crisis. Only popping up into positive territory for brief periods.

The full story

So let’s fast forward 10 years, how does our choice between cash and global equities stand after 30 years?

To put it mildly, the equities have usurped the throne. At the 20 year stage, you’d have roughly doubled your money (in real terms) with both cash and global equities. At the 30 year stage, you’d have a 550% real return with equities. Over the last ten years, you’d have actually lost money on your cash (in real terms).

In other words, if you had held on to tried and tested cash, you’d have massively lost out. This is one of the reasons I bang on at young people about how important it is to start investing as soon as possible. Those sitting out there with all their money in 1% Cash ISAs are getting poorer. If that’s you, I strongly recommend to close this window and open a broker account right now (look at this link on how to do it).

Some lessons

Let’s have a think about what we can take away from all this:

  • Even over very long periods, risky assets might now give you a better return than risk-free assets
  • Cash has historically been a great investment asset
  • But right now, it isn’t
  • That might change, but if you are currently sitting on piles of cash you are losing money
  • But even globally diversified equities are highly volatile, there’s no guarantee of high returns

I have fond memories of my old cash accounts. And I feel it is a shame that cash isn’t the investment it once was. Building societies were a great way to get individuals to start saving for their future. But times have changed. Am I the only one who is nostalgic? I’d like to know if you are too, or if you think I’m being a sentimental fool.

All the best,

Young FI Guy

1 Cash returns data sourced from BSA and BOE. 1989-2007, from BSA 2016/17 yearbook, “Building Society Average Gross Share Rate“. From 2008, BOE “Monthly interest rate of UK monetary financial institutions (excl. Central Bank) sterling fixed rate bond deposits from households (in percent) not seasonally adjusted” – ID:IUMWTFA. These returns are gross, as in before tax. Equities data from MSCI: MSCI ACWI, GBP, Index Gross. Unlike the cash return, you would not have been really able to get this return as I don’t think an index tracker has tracked this index back to the 80s – besides you’d have fees and tax to pay. In that respect, the equities return is overstated by more than the cash return! Inflation data is monthly CPI from ONS: Series ID: D7G7.

2 Datasets for interest rates periodically changed. Prior to 1989, Building Societies were somewhat enforced in the interest rate they had to offer. In the late 80s banking was substantially deregulated giving building societies greater flexibility to set rates (and demutualise). I tried to find the best fit with the BSA data from the various BOE data series. I went for 1 year fixed bonds as that seemed to be ‘the closest fit’.

3 This post is another example of why I don’t like the term “risk”. Risk, as defined by volatility, isn’t particularly helpful to individual investors. I prefer to think of three different types of risk: inflation risk, capital risk and shortfall risk (link).

25 thoughts on “When cash was king

  1. My in-laws had 10,000 roubles set aside for their daughters weddings – with the collapse of the double and break up of the ussr, that sum was inflated away to be worth about a tenner.

    Maybe now p2p is the new cash – limited upside by you get your 5% or.whatever. downside…

    1. Wow! We often forget, but we have it so lucky. Living today, in the UK – it’s kind of like winning the jackpot. My grandmother used to be decked out in gold. She would say that people can take your money but not your gold. Giving how feisty she was, a mugger would have had a real job getting a penny out of her.

  2. Very interesting analysis – that hike from 20 years to 30 years is tremendous. After the next big crash, there will undoubtedly be another such hike – knowing what you know now, would you keep your money in cash or invest immediately?

    I too have very fond memories of my cash accounts – I kinda miss the old passbook which the building societies used to update.

    1. It’s a very hard question weenie. All I know is that I got lucky. I hit the right age to start understanding investing just as interest rates collapsed. I moved my money from cash into investing in 09/10, which, while not quite the market bottom, was close enough to jump on the huge run of good returns.

      I remember those passbooks too! They might still be in the loft. They used to put them into incredibly noisy printers. Good memories.

      1. I loved getting my passbook updated at the Halifax when we nipped into town to “run errands”. Oh the nostalgia of pre-internet banking! I lost a passbook for the Halifax around 1997, and my mum found it around 2012. I took it to the bank to see whats what and I was pleasantly surprised! It was shocking how much the interest fell off the cliff beyond 2008. Of course back then I spent it all on gadgets and designer gear! 🙂

  3. Are the returns you are quoting for tracking the ACWI index price or total (i.e. price + reinvested dividends) returns? Would make a big difference to the outcome over the long term.

    Long term real interest rates have tended to hover around the 3% mark during the 20th century (see https://bankunderground.co.uk/2018/04/04/bitesize-uk-real-interest-rates-over-the-past-three-centuries/).

    Long term real total market returns have tended to be higher. It would be fascinating to compare the total real return of the index against the reinvested return on the cash holdings over your observation period.

  4. This is a very interesting and convenient post to moderate the excessively simplistic view of how investing works and what it means in terms of risk. I miss the years of high interest rates at the turn of the century, when investing in cash ISAs was the smart thing to do. Looking at the chats of the last 10 years I am wondering if this is the moment to start building up cash reserves, as the markets are probably ripe for a downturn, perhaps triggered by Brexit or the new trade wars.

    1. Thanks again Roberto. It was a much simpler time, in that for newbie investors, heading to the building society and opening a savings account was a good move (and much easier than getting to grips with investing).

  5. Pingback: Weekend reading: Child Trust Funds coming of age – Good to Great Mind
  6. Hi YFG – I’m of the opinion there are lies, damn lies and statistics – most stats can be spun to show what you need if you pick your time horizon carefully.

    But I am firmly on board that you need to invest nowadays if you want a return that outpaces inflation.

  7. Re. Saving as a kid, does anyone remember the Post Office savings books? You could buy a savings stamp for 10p, stick it in, and when you filled the page with ten stamps, take it to the PO and pay it into the account. It was a great way for encouraging kids to save.

  8. It took me a while to really appreciate what was going on with cash accounts. I’d been an avid user of building society accounts and I was sat in near zero interest rate accounts for a couple of years after the crisis as it’s difficult creating investment accounts if you live overseas.
    Got fully into equities from 2013. I had to pay a learning cost.

  9. I’m away at the ancestral home – boy I’ve found a treat. Found one of my old passbooks and old interest certificates. When I’m home I’ll try to upload them!

  10. I spent the first half of my FI journey – a journey I didn’t know I was on at the time – with a, what would now be, ridiculous amount of cash. I *was* doing some investing, but for a long time I had more cash (I can ‘turn back on’ tens and tens of closed savings accounts in Microsoft Money and reminisce if I want to). Of course, as you explain here, it wasn’t really a ridiculous amount for the time. The net worth kept going up nicely – after all, the saving rate is the most important thing. Fortunately, I started taking my investing seriously around the time of the GFC.

    1. I think things were much easier to get started back then as cash was a pretty good bet. In some ways, the GFC has been a blessing in that it seems to have kicked quite a few of us into investing!

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