Cash or Stocks? The risk balance may surprise you

The announcement in the last Budget that the annual allowance for cash ISAs is to be cut from £20,000 to £12,000 from April 2027 (except for those aged 65 or over) has caused much comment from those who prefer to keep their investments in cash form.  But is this really the best option, or is investing in stocks and shares a better bet? 

The argument put forward by those who prefer the cash route is that they regard the stock market as too risky.  Whilst it is true that the financial markets are subject to day-to-day fluctuations, over the long-term it could be argued that cash is in fact the riskier choice, because historically the return in cash have largely failed to keep up with inflation. 

That is particularly true today.  Since July 2024 we have seen six cuts in the official Bank of England base rate, which currently sits at 3.75% - as against 5.25% two years ago.  Meanwhile, last month’s CPI inflation rate stood at 3.3%.  The effects of the conflict in the Middle East may well be to arrest the trend of falling interest rates, but it is highly likely to create an inflationary spike, too. 

Finding a cash-based investment vehicle which will even simply preserve the real value of your investment is tricky, especially if it is not wrapped up in an ISA.  Bear in mind that interest on cash savings (after a small savings allowance) is set to be taxed at 22% for basic rate taxpayers and 42% for higher rate taxpayers from April next year.

There are two ways of mitigating that risk of volatility.  The first is to take the long view: whilst markets may indeed surge and fall back on a day-to-day basis, historically the long-term trend has been upwards.  The second mitigation is diversification; often global events will affect just one sector of the market. 

Does this mean that the savvy investor should abandon cash altogether?  Not necessarily – as ever, it depends on individual circumstances.  Above all, it is important to ensure you have enough accessible cash to meet any short-term (i.e. under five years) planned expenditure, as well as any potential emergency expenditure.  The last thing you want to be doing is having to draw from your stock-based investment at a moment when that day-to-day volatility may be working against you. 

It is important to look at the overall picture in each individual case, but a good rule of thumb is that if you are not likely to need to call on your investment in the next five years, stocks will probably be a better bet than cash.