Can cash investors find comfort in smoothing?


Can cash investors find comfort in smoothing?

“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman.” Whilst researching for this article I came across this quote from Ronald Reagan in the L.A Times in October 1978. It may be over 4 decades old but, as our latest Wealth and Wellbeing research can attest, it’s still very much pertinent today as inflation is on the minds of many.

Our findings* have shown that whilst 23% of the mass affluent are likely to have seen an increase to their income over the last quarter, 43% said their outgoings have increased, meaning their budget likely feels more stretched. The mass affluent in particular are worried about their savings being devalued by low interest rates and increasing inflation (24% of mass affluent consumers vs. 15% of the overall population). This is felt most by the mass affluent aged 55 and over, as nearly a third (32%) are worried about this. 

As we know, money that investors place in secure deposits such as savings accounts or Cash ISAs risks losing its buying power over time. This is because the interest rate paid has rarely kept up with inflation since the 2008 financial crisis. Even with low inflation over the last 13 years (to the end of 2020), where the rate of inflation averaged just 2.6% per annum, it should not to be overlooked. 

While we might not feel the impact of something costing £102.60 that last year cost £100, the cumulative effect of inflation over the last 13 years** means that goods and services which would have cost £100 in 2008 would cost £136.45 today. Cash investors over the last 13 years have seen the real value of their capital fall year after year.

If the returns from deposits are so poor, should investors hold cash?

Financial advisers typically advise their clients to hold some of their wealth as cash, with the level dependent on individual circumstances, attitudes to risk and their predicted expenditure over the coming period. As a general rule, clients are advised to hold around 1-2 years’ predicted expenditure as cash so investments do not need to be sold to meet living expenses in the event of investment market volatility. While this might expose these deposits to losing their ‘real’ value, this can prove an invaluable step and has historically provided clients with a huge amount of reassurance during market falls (such as in early 2020 at the start of the COVID-19 pandemic).

It could be debated that keeping in excess of 2 years of expenditure as cash could expose too much wealth to an unnecessary loss in purchasing power due to inflation. Clients holding significantly higher levels of cash may wish to consider deploying this in a way that will keep pace or beat inflation over the longer term.

Smoothed Managed Funds could be an ideal solution for your new and existing clients who are uncomfortable with investment risk, or who cannot or do not wish to expose their accumulated capital to undue risk looking to take action to stop inflation eroding their savings. They could also be suitable for those clients that want to consolidate their accumulated gains and de-risk their portfolios within 3-5 years of their targeted retirement age. 

The charts below show LV=’s Flexible Guarantee Bond Cautious fund’s 5-year performance versus CPI and a 90-day notice savings account and it’s clear to see the negative real returns of cash deposits and the positive real returns of the Flexible Guarantee Bond Cautious fund.
graph showing 5 year performance of cautious fund
Taking a look at a simple measure of a fund’s risk can be a good way of helping clients understand how investments behave. FE fundinfo Risk Scores define risk as a measure of volatility relative to the FTSE 100 index, which has a fixed risk rating of 100. The Risk Score scale starts at zero, and in theory has no upper limit. Scores are recalculated weekly on a rolling 3-year total returns basis.
graph showing fe risk score from november 2018 to september 2021
As you’ll see in the second graph, cash has a FE risk score of 1, the FTSE a score of 100, ABI Mixed Investment Portfolio a score of 24, and the LV= Flexible Guarantee Bond Cautious fund a risk score of 4. So for a relatively small increase in risk, clients can benefit from the potential of being invested in real assets to protect against the perils of inflation. 

More information on LV=’s Smoothed Managed Funds

In exceptional market conditions (when the underlying price is 80% or less of the averaged or ‘smoothed’ price) the fund will typically be valued on the underlying price. Or, using our discretion, may be valued on the daily gradual averaged price with a shorter smoothing duration. We reserve the right to move to the underlying or gradual averaged prices at other times.
*Source: LV= Wealth and Wellbeing monitor, conducted via Opinium Research in September 2021. 
**Source for all inflation data: Bank of England.