Hold cash: returns are better than you think

If you look at any historical analysis of stockmarket returns, one thing stands out pretty clearly: over most periods, holding equities serves you much better than holding cash. Take the gold standard of equity return analysis, the Barclays Equity Gilt Study, and you will see that since 1899 equities have returned 4.9% a year on average in real terms (over inflation), while cash has returned a mere 0.9%. Then look at the conventional wisdom as quoted by Pete Comley in his new book, Monkey with a Pin.

According to the Motley Fool website, "over periods of five years the returns from shares have historically beaten cash around 80% of the time; over ten years that rises to about 90%; and for 20-year periods it's 98%". Look at numbers like that and it is no wonder that so many of us feel so tense about keeping money in cash.

But what if the case against cash it not quite what it seems? Comley points out that the 'cash' used in most of the calculations is not quite the same as the cash you and I are holding. Instead, the Barclays study uses UK Treasury Bills. These have a minimum purchase level of £500,000, which puts them out of the reach of most British investors (the bonus-wallowing chief executives of our big firms aside).

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They also come with interest rates that more or less mirror the base rate a rate that is almost always well below the rate we actually get on our deposits. Today, for example, the base rate is 0.5%, but the best accounts on the market are paying out up to 4.5% in interest.

So how much difference does this make? Comley has had a stab at figuring it out by looking at the best buy tables for instant-access savings accounts every year since 1990. Sure, this is a shorter period than that covered by the 100-year studies. But it should still be of interest that the results show that over the last few decades the return from cash has been underestimated by around 1.3%. Extrapolate that back and the gap in real returns between cash and equities starts to narrow. It narrows even more if you add back in the charges you pay as an investor in ordinary funds in Britain (Comley reckons that all in, the average British investor makes an average long-term return of 1% a year!).

The point? While we are all conditioned to think that holding cash is a bad thing, it isn't nearly as destructive to your wealth as the industry would have you believe. Indeed, at times when markets look expensive (as the US and emerging markets in particular do at the moment), holding cash in a high-paying deposit account is a pretty rational path to take. You can download Comley's ebook (it's free) at www.monkeywithapin.com.