Over the last 100 years equities have delivered the best long-term returns for investors.
As statistics continue to confirm, despite years of record low returns from money on deposit, cash is still the home of choice for the long-term savings of many people. Latest figures from HMRC confirm that over three-quarters of ISA subscriptions in 2013-14 were to Cash ISAs¹. Yet history shows that investing in equities is the best way to achieve long-term returns.
Nothing tells that story quite as simply as our chart, which traces the very significant long-term cost of trusting only in cash. The chart follows the progress of £1 invested in 1899 in a savings account, in bonds, and in equities. The £1 in savings would today be worth £3 in real money – that is, after taking account of the effects of inflation. The same investment that went into bonds would have done a bit better, but not much. It would be worth £5. But the £1 that was used to buy equities would have grown to £348, more than 100 times the cash option.
Source: J.P. Morgan, data to 31/12/2014. Please be aware that past performance is not indicative of future performance. The value of an investment can fall as well as rise. Returns on equities cannot be guaranteed. Equities do not provide the security of capital characteristic of a deposit account with a bank or building society.
The message is clear - investing in shares offers the best prospect of achieving long-term capital growth. It's important to have a diversified portfolio, but you also need to keep an eye on it so that it doesn't become more unbalanced over time, as some investments grow faster than others. Properly managed, however, equities have proved to be the winning option.
Why have equities been able to outperform by such a large margin? One of the principal reasons is their different relationship with inflation. If you buy bonds or put money into a deposit account, you know in advance what the investment will be worth at maturity. Inflation is the enemy, and can only eat away at that value – the higher the inflation rate, the worse the damage. But inflation is not the enemy of shares and may even be their friend.
In inflationary times, companies put up their prices. That helps them to raise their profits and, as a result, their share prices and dividend payments should also be boosted. So even as inflation is savaging returns from cash and bonds, equity returns can grow in line with it or even outpace it. That's why shares are often seen as a hedge against inflation. Even when inflation is low, share prices will rise gradually as companies benefit from higher productivity and general economic expansion.
Stay the course
Staying aboard for the long term is also a crucial part of the process, as another look at the chart reveals. That's because every now and then, in between more energetic bursts of growth, the stock market goes through periods of prolonged sideways movement. The period between 1913 and 1922 was one such flat period. There was an even longer one between 1936 and 1950, which included the massive disruption of World War II. The lost decade of the 1970s, riven by industrial unrest, was followed by the booming 1980s and 1990s, which were stopped in their tracks by the bursting of the dot.com bubble and then the financial crisis.
This short-term rising and falling can be painful, even alarming, for investors, which is why some prefer to seek shelter in cash. The downside for cash is minimal – returning a mere 0.5% in its worst years, against -24.1% for shares. But the upside for cash is minimal too. Take one step back and it's clear that, over the longer term, equity markets are simply regrouping and consolidating, before taking the next step up.
The information contained above, does not constitute investment advice. It is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Full advice should be taken to evaluate risks, consequences and suitability of any prospective fund or investment.
¹ HMRC, April 2015