Investments or Cash?

Interest rates are at levels that we have not seen since before the Financial Crisis, tempting people into cash, and away from investing.

So, does investing even make sense anymore?

Let’s consider a few fundamentals:

• Governments must pay higher returns than cash to borrow. Governments need to raise money through debt. It’s what keeps pensions paid and the lights on. If cash rates are at 5%, government bonds have to offer people more than that to tempt them out of the bank – even more so if they want them to lock their capital up for 10 years.
• Companies must pay more than governments to borrow. Companies need to incentivise investors to lend to them, rather than to the government, which means paying more than the government does. If cash is at 5%, and let’s say that government bonds are at 6%, corporate debt must be higher. Otherwise, why would anyone take the risk on the company?
• Equities (shares) have to offer the chance of being paid more than corporate bonds. Companies also need to generate money for their shareholders, who are taking even more risk than their bondholders. If their shareholders could do better leaving their money in the bank, soon there’d be no shareholders.  The decision maker at a company knows this. Any new project requiring a cash investment will be judged against the bank rate. If a new project doesn’t have the potential to beat what the bank’s offering, why would they do it?
  The bottom line is that cash sets the bar. Everything else then needs to jump over it.

Of course, it’s tempting to believe that today’s investment circumstances are unique. “Maybe this time it’s different”.

Inflation has been high and Government debt levels have soared. Geopolitical hotspots have flared up in Ukraine, the Middle East and Taiwan. Add to that the transformational developments in AI and the increasingly savage impact of climate change.

But is it really different this time?

Let’s look at the below chart. Between 1993 and 2007, interest rates averaged 5.35%. Government debt levels were rising sharply. Geopolitical hotspots were flaring up in Yugoslavia, the Middle East and Russia. The internet was revolutionising society.

In the face of all that, surely just staying in cash, at 5.25%, was best?