Cash vs shares

New analysis of asset class returns published by the BBC journalist Paul Lewis has turned heads in recent days – not surprisingly, since it appears to suggest the historic long-term investment performance of stock market investments is nowhere near as superior to the returns generated by bank and building society savings accounts as is generally assumed. However financial advisers tempted to change their asset allocation policies in light of this research might like to take a look at the Association of Investment Companies’ data.

First, Mr Lewis’s figures. The Radio 4 presenter based his analysis on a fund that tracked the FTSE 100 Index of blue-chip UK shares over 192 different five-year periods between 1 January 1995 and the present day. Then Mr Lewis looked at what you would have earned from cash during these same periods, assuming that you put your money into the top-performing savings accounts, switching your money once a year if necessary to capture a more competitive interest rate.

The findings are certainly arresting. Mr Lewis found that the ‘active cash’ approach turned out better than the tracker fund investments in 57 per cent of the 192 five-year periods, with the funds only outperforming over 43 per cent of periods. And while the cash option never lost money, investors in the tracker funds found themselves in the red around a third of the time over investment periods ranging from one to 11 years.

So does that mean the stock market doesn’t generally outperform cash over longer-term periods, as we’ve always been told (albeit with the usual caveats around past performance)?

Well, there are a couple of flaws in the research. First, all the evidence is that people with money in a savings account are very unlikely to move it regularly in order to capture the best interest rates, as in Mr Lewis’s analysis. If they did, the business model in the savings account market would probably have to change, with providers no longer able to compete using high introductory interest rates that subsequently fall back. The more significant issue is that this is a comparison between apples and pears – Mr Lewis studied cash returns on the basis that they were actively managed, but compared them to passively-managed stock market funds.

To get an idea of where decent actively-managed stock market funds might fit into this picture, consider the data published by the Association of Investment Companies. It looked at the share price performance of closed-ended funds in the UK All Companies sector and compared this to what a high interest cash account has delivered. The AIC’s analysis, based on 31 May data, shows investment companies outperformed savings accounts over three years, five years, 10 years, 15 years and 21 years (the full term of Mr Lewis’s study).

Indeed, the contest over longer time periods wasn’t even close. Over five years, the typical UK All Companies fund turned £100 into £163.99 according to the AIC, against £102 for a high interest-savings account. Over 10 years, the respective figures were £227.79 and £111; and £844.18 and £160 over 21 years. The sector has also beaten the market, as measured by the FTSE 100 Index, over all these periods, which means the average fund will have done better than the trackers in Mr Lewis’s research.

It helps, of course, that investment companies have been able to deploy gearing to augment their returns during rising markets – that’s not an option for a savings account provider (or the managers of open-ended funds for that matter). Also, the average investment company currently yields around 3.5 per cent and investors able to reinvest their dividend income get a significant boost.

None of which is to suggest that Mr Lewis’s work is not food for thought. It’s an important contribution, for it has become all too easy simply to assume that the stock market will outperform over the long term. Financial advisers know most of their clients need a balanced portfolio of assets, including cash and equities.

Nevertheless, it’s important to be careful with Mr Lewis’s research. Financial advisers understand that many actively-managed stock market funds genuinely have performed much better than stock market indices and tracker funds – as well as cash. It’s not time to retire the old rules of investment just yet.