Why ‘lane envy’ can be dangerous for your finances

Chopping and changing lane doesn’t help you get to your destination quicker. And it isn’t any better a strategy for your finances either. Higher interest rates can make some short-term measures more appealing – but they can actually be damaging... Read more

Man driving and considering changing lanes

Blog17th Jul 2023

By Martyn Paterson

Chopping and changing lane doesn’t help you get to your destination quicker. And it isn’t any better a strategy for your finances either. Higher interest rates can make some short-term measures more appealing – but they can actually be damaging for your long-term goals.

Picture this, it’s summer holiday time and you’re sitting in traffic. Cars either side on the busy motorway are inching past. Frustrated, you switch lanes, only to find that it’s now the other lines of traffic moving ahead.

It’s an illusion though, as studies, like this one from Stanford University, show that switching in and out can be unnecessarily risky.

We’re seeing evidence of this ‘lane envy’ just now with regards to the UK’s current economic climate.

Interest rates are at their highest in nearly 15 years, meaning some conventional savings accounts look – at least temporarily – more attractive than investing in stocks or bonds. Clients have come to us tempted by the short-term potential of moving some of their money into cash, thinking they’re getting a better deal.

We always advise strongly against this. Ultimately, it can be harmful for your finances.

The current state of play

Let’s take a brief look at what’s happening now.

In June, the Bank of England put interest rates up to 5%. It’s the highest level for the cost of borrowing in nearly 15 years – and a far cry from the rock-bottom levels seen over the last decade.

The rise is very bad news for mortgages but it’s a boost for cash savings. Current deals on offer are up to 4.15% for easy access or 5.7% for fixed rates.[1]

At the same time, equity markets have been up and down. Since the start of the year, the FTSE All Share Index rose at one point to more than 7% from the start of the year but has dropped back down to roughly where it started (go further back, however, and the market returns looks much healthier).

Why we should avoid thinking short term

During these times of what we call market volatility, it’s a natural reaction that investors consider heading for so-called ‘safe havens’. With interest rates pushing up the potential returns from cash savings, could these deliver what they’re looking for?

Firstly, we need to consider the negative impact of changing lanes.

Taking your money out of the market and into cash can be disastrous for the long-term earning power of your portfolio. If we take a hypothetical portfolio of 100% equities with a return of 7% (a fairly conservative estimate over the long term) and compare it with one that’s split between cash and equities over 20 years the mixed portfolio earns considerably less. The example in the chart below, assuming cash return of 1% interest of 3% interest shows that the split portfolio brings the investor between £66,000 and £95,000 less.

Graph showing how much switching to cash can cost your portfolio

For illustrative purposes only. Assumes a hypothetical 7% return for shares after costs

Secondly, growth is like London buses. It goes away, then it all comes at once.

The main problem for investors is that once out of the market, it’s extremely difficult to get back in. Few – if any – investors can time the market to the degree they can avoid the worst days and still be there for the best. As an example, the chart below shows how much the return would be from various points over the last decade.

So, when growth does return to the market, it will be too late to buy back into any potential bounce. You’ll have missed a golden opportunity.

Graph showing FTSE All Share returns from start of calendar year to end of May 2023

Chart shows FTSE All Share returns from start of calendar year to end of May 2023.

Open road ahead

Let’s return to that situation we discussed at the beginning of this article. Stuck in heavy traffic en route to your summer holiday. Imagine if after 20 minutes of queuing you’re offered the chance to get on a bike.

In theory, you’ll be free to weave in and out of the traffic. In the short term you’ll be well ahead of those around you. But of course, you know that once you hit open road and the traffic clears, you’ll be left with the wrong tool for the job.

That’s the difference between a short-term fix and long-term thinking. It’s putting the temptations of a temporary good deal to one side, knowing that it could be detrimental to the end goal.

Despite a fair amount of doom and gloom in the news headlines, markets are on a slow and steady march upwards. We’ve discussed here before the benefits of having a plan and sticking to it. So this summer, when panic sets in and you feel like you’re in the wrong lane – remember the fear you’re not moving as fast as you should be could just be an illusion.

If you are unsure about the state of your investments or of the financial markets and would like more information, please contact us or get in touch or your usual AAB Wealth contact.

[1] Money Saving Expert as of 22 June 2023

By Martyn Paterson

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