Vanguard Asset Management | Personal Investing in the UK (2024)

The sharp declines in many global markets in 2022 underlined how the value of your investments can go down as well as up.

But that’s the nature of investing: there will be bad times as well as good, but hopefully more of the good times. Shares don’t move in straight lines, but historically they have tended to move higher over the long-term.

Here are five reasons to invest in shares over cash right now.

1) The limitations of cash

Many investors in the UK have never faced double-digit inflation. When prices rise quickly, people’s wages often are unable to keep pace, so their overall spending power is reduced.

That can have a devastating impact on the value of your money, as illustrated by the chart below, which shows the recent return on cash (using Libor – a wholesale bank rate – as a proxy) adjusted for the effects of inflation.

Returns from £10,000 in cash, before and after the effects of inflation

Past performance is not a reliable indicator of future results.Notes: Cash returns represented by the Intercontinental Exchange (ICE) Libor GBP 3-month benchmark; inflation by the UK Retail Price Index.

Source: Factset, Vanguard calculations based on period 31 December 1998 to 31 December 2022.

To slow economic activity and, consequently, help control inflation, central banks like the Bank of England usually raise interest rates. This, in turn, feeds through to higher savings rates, which can help to counter some of the effects of inflation for cash savers.

At some point, savings rates could even rise above the rate of inflation.

However, with UK consumer price inflation at 10.4% at the last count in December and the Bank of England’s policy rate at 4.2%, that’s still some way off. Our own economists don’t expect interest rates to rise above inflation until the end of this year. Even then, as the above chart shows, the fact remains that cash historically remains at the mercy of inflation.

This is why it’s worth considering whether putting your money to work in different ways can help grow your wealth more effectively.

2) Shares are historically a better inflation hedge

Compared with cash, shares have a far stronger long-term track record when measured against inflation.

As the table below highlights, the average inflation-adjusted annual returns for shares stretching back more than 120 years is more than 5%, whereas for cash it’s only around 1%.

How shares have fared compared with cash and bonds: total returns 1901-2022

Past performance is not a reliable indicator of future results. Notes: Data cover 31 December 1900 to 31 December 2022. Returns are in GBP. Nominal value is the return before adjustment for inflation with dividends and income reinvested; real value includes the effect of inflation.

Sources: Vanguard, using Dimson-Marsh-Staunton global returns data from Morningstar, Inc. (the DMS UK Equity Index, DMS UK Bond Index, DMS World Bill Index).

As last year’s market falls showed and the table also highlights, shares (and bonds) are more susceptible to market uncertainty than cash. The key point, though, is that investing in shares can help grow your wealth more effectively in inflation-adjusted terms than cash can over the long term.

Consider our first chart, for example, which showed the real value of £10,000 in cash over time once adjusted for inflation. Now see the same chart reproduced below, but with the performance of a global stock market index superimposed. Although it’s not possible to invest directly in an index (you can only do so through a fund, which involves costs) it does give you a sense of the bigger picture.

Returns from £10,000 in cash and shares, before and after the effects of inflation

Past performance is not a reliable indicator of future results.Notes: Cash returns represented by the ICE Libor GBP 3-month benchmark, global shares by the FTSE All-World Index with dividends reinvested; inflation by the UK Retail Price Index.

Source: Factset, Vanguard calculations based on period 31 December 1998 to 31 December 2022.

We would caution investors against being put off investing by one negative year of returns. As we go on to explain, falling markets usually mean better investing opportunities going forwards.

3) The ‘equity-risk premium’

The key reason to invest in equities (or shares) over cash for long-term growth is due to something known as the ‘equity-risk premium’. This is the idea that, because stock returns are more volatile than cash saving rates, investors should be rewarded for bearing this additional risk.

It is why shares deliver better inflation-adjusted returns in the long run – as the table above illustrates.

So, if you can bear the increased risk (because you have a longer time horizon, for example), then the case for investing in shares over cash remains intact.

Remember also that much of the trade-off between risk and potential reward can be managed by investing in shares through funds, which can diversify your investments across thousands of different companies. In addition, you can adjust the blend of shares and bonds to match your own risk preferences, in keeping with the second ofVanguard’s four principles.

4) We think shares are better value now

After a poor performance globally in 2022, shares, in our view, are better value now. As a result, their long-term prospects have improved too.

That’s reflected in the Vanguard Capital Markets Model® (VCMM), which analyses historical data and simulates thousands of projections, using a series of forward-looking assumptions and indicators. It now calculates that a UK investor can expect global shares (excluding the UK) to return between 5.3% and 7.3% a yearon average over the next 10 years³.

For UK shares, our range of long-term expectations are unchanged year-on-year at 4.6%-6.6% per annum. The lack of movement in our UK return expectations reflects the relative resilience of the UK stock market’s performance.

These projections are purely hypothetical – there is no guarantee of them happening. Under the circ*mstances, they are nonetheless encouraging and reinforce why investing in shares rather than cash may make more sense for investors in the long run.

5) Uncertainty over interest rates

Finally, it can’t be assumed that interest rates will continue rising or stay higher forever. You may be able to lock in higher interest rates at the moment. But this doesn’t go much beyond six months, and beyond that, there’s uncertainty over what will happen to policy rates. And while trying to time that well, you might miss out on strong stock market performance.

Our economists expect the Bank of England’s main policy rate to peak in the next few months at about 4.5%. At that point, we think the aggressive rate-hike cycle we’ve seen to date will plateau over the remainder of 2023.

If inflation comes down faster than expected, it's possible that interest rates go down again.

In the long run, our economists believe UK interest rates will settle at around 2.5-3% once inflation returns to target and the economy is in equilibrium.

¹UK Treasury bills are used here as a proxy for cash.

²Greatest annual loss is represented by the lowest 5th percentile of annual returns.

³The probabilistic return assumptions depend on market conditions at the time of the running of the Vanguard Capital Markets Model® (VCMM) and, as such, can change with each running over time. The projections listed above are based on a running of the VCMM based on data as of 31 December, 2022. Please note that the figures are based on a 2-point range around the 50th percentile of the distribution of return outcomes for equities and a 1-point range around the 50th percentile for fixed income. Numbers in parentheses reflect median volatility.