Should you save or invest when cash pays 5%-plus?

Even the most enthusiastic long-term investors are more than likely looking for the best buy-save interest rates right now.

One-year fixed rate bills are already paying up to 5.70 per cent, and more rate hikes seem set to take hold as the Bank of England struggles to quell stubbornly high inflation.

Guaranteed savings returns that look high – and rising – attractive compared to the risks of investing.

Still, research shows that stock market investments are still likely to outperform if you commit your money to the financial markets for 10 years or more.

We ponder the saving versus investing conundrum and gather expert tips on how to position your investment portfolio and make your cash more productive in a time of continued inflation and high interest rates.

Savings versus investing: the long-term winner is well established

According to recent research in the financial industry, investors are increasingly looking to cash options over long-term equity investments as interest rates continue to rise.

Schroders UK Financial Adviser’s Pulse survey found that 90 percent of advisers had spoken to clients about the benefits of cash versus long-term investments in the stock market.

Some 44 percent of advisors report that clients remain cautious about investing in the stock market, though that’s down from 68 percent in November last year.

In the current circumstances, it is understandable that you prefer to keep your assets in cash, but experienced investors with a long-term strategy and a well-positioned portfolio will not want to make hasty revisions.

In a recent column, This is Money’s Simon Lambert says, “Many studies over a very long time have shown that over longer periods of time, the stock market has provided the best chance of a real return on your money, that is, one that beats inflation.”

He cites the influential Barclays Equity Gilt Study 2023, which found that the probability of stocks outperforming cash over 10 years is 91 percent.

However, he also points out that these kinds of studies usually use the Bank of England base rate or an average savings account to reflect cash.

But recent research from This is Money has shown that you can do much better than the average saver by transferring your money to the best easy access rate once a year.

Rob Morgan, chief investment analyst at Charles Stanley, says: “Higher inflation tends to be a negative factor for most investments, such as stocks and bonds.

“When inflation and interest rates are high, investors demand a higher yield, which means a lower value to begin with.

However, markets always look to the future and they have already priced in a lot of what we see happening now. That’s why they’ve had such a hard time in the course of 2022.’

Morgan says the most important thing investors can do is build a portfolio that seizes opportunities but is also resilient in a variety of scenarios, including an environment of more sustained inflation.

What can investors do to combat stubborn inflation?

According to Morgan, you need to diversify by asset type, geography and type of company. He gives the following portfolio tips.

Raw materials: ‘Including commodities stocks can sometimes help, for example stocks of companies that produce oil, gas and metals.

“If their prices rise during inflation, it can benefit the companies that produce them. However, they can also be volatile and it’s best not to have so much in one sector that it starts to dominate returns.”

dividends: Stocks that regularly pay dividends to their shareholders may be more resilient in times of inflation.

Dividend income can help offset the effects of inflation, and companies that can maintain profits and margins as prices rise can be particularly valuable.

“These stocks can be found in a wide variety of industries, but those that produce essential goods and services that people or businesses still need or want to buy when prices rise tend to have an advantage.”

Resistance: “In particular, sectors such as healthcare, utilities and infrastructure are worth considering, as are certain areas of consumer goods where there is still a drive to buy at higher prices, such as beverages, medicines, cherished foods and fashionable clothing.

“Companies selling these types of goods can make price increases with less impact on volumes, potentially outperforming companies selling in areas where consumers are more likely to economize or switch to a cheaper alternative.”

Your savings options – and don’t forget your pension

“Stubbornly high inflation is not good news for savers, as nominal interest rates are still well above the best savings deals, so any returns will still be negative,” said Alice Haine, personal finance analyst at Bestinvest.

But with savings rates rising dramatically in recent months — by more than 4 percent on easy access accounts and 5.7 percent on fixed-term accounts — and inflation still expected to ease over the course of the year, savers ultimately their money gains value in real terms.’ Haines offers the following tips.

Best Rates: Funds left in an account with an ultra-low interest rate languishing into a new account with a better return will pay off in the long run.

“Remember that while an easily accessible, high-interest savings account can be a great place to hold a rainy day fund to cover six to 12 months’ worth of expenses, additional funds require a more tax-efficient approach.”

> Top accounts over one, two, three and five years, And best rates for easy access

Softens load: As interest rates continue to rise and income tax thresholds are frozen or lowered, more people could find that their existing cash savings are at risk of exceeding their personal savings deduction.

This allowance, which allows savers to earn interest on their savings without paying tax, has remained the same since 2016: basic rate taxpayers get a generous £1,000 PSA, those paying the higher tax rate of 40 per cent are entitled to an allowance of £500 and taxpayers who receive no savings deduction at all.

“Savers looking for a more tax-advantaged option should consider using their £20,000 Isa benefit, which will allow them to earn income and earn a return without paying tax.”

Use your pension: Savers who want to beat inflation in the long run while reducing their income tax liability should supplement their pension funds.

With the lifetime allowance now scrapped – at least while the Conservatives are still in power – and the annual allowance increased by 50 per cent to £60,000, savers have a chance to increase their contributions to their workplace and personal pensions.

“This can be a very beneficial strategy when both inflation and the tax burden are so high that retirement savings offer a generous tax break, applied to people’s contributions at their marginal income tax rate.”