With savings rates rising, investors can get an attractive return in cash. However, there is still an argument for stock market investment, says David Goldman, manager of the BlackRock Income & Growth investment trust.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
For more than a decade, savings rates had been anaemic. Investors could expect no more than 1-2% interest on their cash holdings. Today, it is possible to get 4-5% interest on a savings account, which begs the question: why invest in the stock market?
This is a pertinent question after a turbulent 18 months in stock markets. Stock markets saw a significant decline in 2022 and despite a better performance in 2023, have not yet reached their previous levels pre-2022. It is tempting to see 5% on cash as risk-free income, rather than put up with the caprices of stock markets.
Cash has a role in financial planning. It can help provide a safety net, bring some optionality to a portfolio, or fund short-term spending needs. But we would argue that for long-term savings, it is still important to invest in the stock market.
Inflation
The first point is on inflation. While cash savings rates look superficially high, they need to be set against the context of high inflation. If inflation is at 2%, a 5% income is attractive. If inflation is at 7%, then it is less appealing. Savings rates may have risen, but savers would still see the purchasing power of their capital diminishing.1 Over a 10 or 20 year time frame, this may become a significant drag on long-term savings.
The stock market has historically performed better than cash. The recent Barclays Equity Gilt Study showed that over the past decade, equities returned 8% per annum2 after adjusting for inflation. By contrast, cash lost 1.9% per year in real terms.
There are sound reasons for this. Companies may experience inflation in the form of higher costs, but they can also pass price rises onto their customers. This may help them maintain their profitability at times of higher inflation, which, in turn, may support share prices.
It should be said that this is not universal. Not all sectors have the ability to pass on price rises. Regulated sectors may be limited in the extent to which they can raise prices, for example, while some highly competitive consumer sectors may struggle to push through increases on under-pressure households. Therefore, some selectivity on companies and sectors is particularly important at times of high inflation.
Dividend growth
With cash holdings in the bank, the rate of interest is generally fixed, though banks may vary the interest rate. In contrast, companies could grow their dividends over time, will aim to pay out progressively more to shareholders year after year. For the BlackRock Income & Growth trust, this allows us to target a progressive dividend policy and aims to build our payouts each year.
What does this look like in practice? If an investor buys a share at £100 and it pays a potential return income of £3.5 the share price may rise or fall, but if the dividend grows, that investor may be getting £3.75 next year, and £4.50 the year after, all from their original investment.
Volatility
Earnings from investments (dividends) are often steadier than the changing value of the investments themselves. This is because dividends depend on the operational performance of an individual company rather than market sentiment. The aggregate dividends of companies in the FTSE 100 have grown every year since 2015,3 except during the pandemic disruption of 2020.
On the BlackRock Income & Growth trust, our focus is on finding companies that generate sufficient cash to grow their payouts to shareholders over time. We look to uncover these companies in the UK market, which has a rich history of paying dividends to shareholders. Our current yield is 4%, but our aim is to ensure that dividend grows over time, while also growing shareholder capital.
Rising interest rates have created a new landscape for investors, but higher interest rates does not derail the argument for stock market investment in the longer-term. Equities remain a potential tool to protect a portfolio against inflation, and to grow income over time.
Sources:
1 Trading Economics – Interest rate – 10/11/23
2 UK Dividend Monitor - Computershare – 30/10/23
3 Stocks adjusted return - MarketWatch – 27/05/23
Risk Warnings
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Trust Specific Risks
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Gearing Risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
Liquidity Risk: The Fund's investments may have low liquidity which often causes the value of these investments to be less predictable. In extreme cases, the Fund may not be able to realise the investment at the latest market price or at a price considered fair.
