CASH VERSUS INFLATION
Tell any financial adviser you prefer cash because it gives a guaranteed return and chances are they will tell you the only thing guaranteed is that you will lose money because it will be eaten away by inflation. And if you reply 'yes but I don’t want to take a risk' the response will be that there is a risk with cash – indeed a certainty – that your savings will worth less in real terms when you take them out than when you put them in.
This research shows that advice is generally wrong, at least for those who actively manage their cash deposits. So financial advisers should be very cautious in telling clients those things. It may be seen as not treating them fairly or fulfilling their consumer duty. This blogpost will help them get it right.
The numbers
Cash returns and inflation can be
measured precisely over the past. Some numbers go back to the 1990s and there
are detailed figures for the whole of this century. But there are choices to be
made.
First, how do we measure cash returns? On the face of it there is a plethora of different ones. Every bank and building society decides on the interest rate it pays and the latest Moneyfacts for May 2025 devotes ten pages to around 150 different institutions which can each offer 80 or more rates on different sorts of savings. Even its Savings Selection page of the accounts with the highest rates has eight tables with a total of 304 cells each of which can show a different rate.
So Active Cash™ - which I trademarked in 2016 - has one simple rule. You pick the best one-year fixed rate deposit account - often called a bond - and when it reaches its term use the money from it to buy the best bond then. It is a simple rule and takes just a few minutes once a year to implement – go online and find the best buy one year bond and put your money in it. With faster payments the money can come out of one bond and go into next year’s choice on the same day.
The figures used in this analysis are from Moneyfacts ‘Savings Selection’ page. They are the best rate in the '1 Yr' column of the table for fixed rate accounts. I am grateful to the money data firm for giving me access to the rates paid on the best buy one year bond each month from January 1995 – more than 30 years of data. They can be found here.
Second, how do we measure inflation? The Retail Prices Index (RPI) was the preferred choice until April 2011 when George Osborne changed the official measure to the Consumer Prices Index (CPI). Nowadays the Office for National Statistics (ONS) boffins prefer CPIH which includes housing costs. For simplicity, I have picked CPI which ONS has back-calculated as far as we need it and the monthly percentage rise in prices over the previous 12 months is easy to download from the Office for National Statistics website.
With those choices made, comparing Active Cash™ rates with CPI inflation needs just two columns of numbers for each month.
The comparison
For each starting month I have
calculated the return on Active Cash™ over a set number of years and compared the
return with the rise in the CPI over that same period. If the total Active
Cash™ percentage return is bigger than CPI then at the end of the period your
money is worth more. If it is smaller then it is worth less. I picked one, two,
three, four, five, and ten years.
For example, if you put £1000 into the best one year bond in October 2003 the interest rate is 4.6% so by October 2004 it would be worth £1046. But inflation over that period to October 2004 was 1.2% so the real value of your money after a year is £1033.60. If you then go on to put that £1046 into a best buy one year bond and again and again over five years by October 2008 your £1000 would have grown 30.616% to £1,306.16 but inflation over that period was 13.109% so the real value of your £1000 after five years was £1154.78 a real terms increase of £154.78. Over ten years the real terms increase by October 2013 would be £223.65. The calculations show that for any starting month before March 2009 and over any of the periods Active Cash™ beats CPI inflation.
For later years that is no longer true. Put £1000 into the best buy one year bond in July 2020 then the real value of that after one year would be £991.18, after three years would be £874.43, and after four years would be £906.95. So it is clear that with some starting months your cash will grow in real terms but in others it will shrink.
Over time
To see the outcome over many years
I picked two periods – this century which means buying a one year bond starting each month from January 2000. And the last sixteen years – doing the same from
March 2009. That month was picked because it is the first for which the
return on Active Cash™ fell below inflation. From that date the calculations show many starting months when it beats inflation and many when it does not. It
is a simple matter to count each outcome.
From January 2000 Active Cash™ beat inflation in all five periods of 1, 2, 3, 4, 5, and 10 years. The worst period was 2 years at 71% of the starting months; the best was 85% of the starting months over ten years.
Taking the first quarter of this century, the average real (after inflation) return on £1000 invested each month is a compound increase of around 1%. So active cash does beat inflation.
From 1 March 2009 Active Cash™ also beat inflation in all five periods. The range was 51% (two years) to 64% (five years) of the starting months. In other words, stick a pin in a random start month and a random period and Active Cash™ is more likely to beat inflation than not.
From January 1995 to February 2009 Active Cash™ beats inflation in every single starting month over all five periods for as long as these records go back. So before March 2009 cash managed this way always beat inflation.
From March 2009 the results become mixed. The financial crisis of 2008 led to a period of high inflation and then historically very low interest rates and there was very high inflation in 2022. So there are blocks of time where cash does not beat inflation.
Now in 2025 we may be entering a different and more normal era. From August 2022 Active Cash™ beat inflation over two years for every starting month. And over one year for every starting month from November 2022 buying a best buy bond has outperformed inflation. In that month the best buy bond paid 4.5% and when it matured in November 2023 inflation over the 12 months it had been held was just 3.9% so it beat inflation and that has been true in each of the eighteen months since up to April 2025.
When an adviser tells you that you are bound to lose money in real terms with cash it is simply not true overall if you manage it properly. And for that, Active Cash™ is the key.
FURTHER ANALYSIS
Behaviour
The biggest problem with this
analysis is that Active Cash™ is not how most people behave. If you leave your
money languishing in an average account either as a one year bond or in an easy
access account then the figures are very different.
Easy access is generally the worse. Using Bank of England figures for what it calls ‘sight deposits’ which you can take out whenever you want and which pay variable interest rates, the best that cash can do from 2000 is beat inflation 43% of the time over one year and the worst is just 8% of the time over ten years. Since March 2009 it is better at the most for only 14% of the time and over longer periods it is never better. This analysis assumes that the interest paid remains at the average for the whole 12 months. That is not normally true but the effect is unlikely to change the overall picture.
There is £280 billion in bank accounts that pay no interest. That money is indeed guaranteed to lose its value over any period, even one month.
Buying an average one year bond each year does better than average sight deposits, but of course not as well as buying the best. Using Bank of England numbers for the average rate paid on one year bonds you would still beat inflation for bonds bought in most months of this century – 52% to 59% of months would do that depending on the period over which you did it. But from March 2009 the figures are much worse. Over ten years a bond bought in any starting month would not beat inflation and over the shorter periods only between 38% (one year) and 14% (five years) would beat inflation.
Protection
People with a lot of cash savings
face another problem with Active Cash™ – there is an £85,000 compensation limit
if the bank or building society where their money is saved goes bust. Very
cautious people split their savings so that no bank or building society has more than
that in it. That means of course that not all their money can be in the best
buy account. However, the difference between the top five is not great – it currently
ranges from 4.52% to 4.4%, all still comfortably above inflation which has just hit 3.5% and which the Bank
of England predicts will stay high this year before falling again. In
December it is expected that the deposit protection limit will rise to £110,000
so people with £500,000 will be able to safely earn above inflation increases in
their cash deposits spread over the top five accounts.
Tax
The figures take no account of income
tax that may be due on the interest. For basic rate taxpayers there is a £1000
tax-free savings allowance and they would need more than around £22,000 in
savings to currently earn enough interest to exceed the £1000 allowance where
tax is due. For a higher rate taxpayer the figure is half that as the allowance
is just £500. Tax could be mitigated by using Active Cash™ techniques on cash ISAs
where the interest is all tax-free. But there is a limit on putting money into a cash ISA - currently £20,000 a year. And no long-term data is available to allow the
ISA calculations to be done. Cash ISAs currently pay interest at very
similar levels to taxable savings accounts but that has not always been the case.
Inflation choice
CPI was chosen because it is the
current standard way of measuring inflation. The calculations could also be
done using
- RPI
- RPI until March 2011 and CPI from April 2011
- CPIH as back calculated by ONS.
Putting these rates into the calculations does not materially affect the outcomes overall, though of course with a measure that gives higher inflation, Active Cash™ beats it less often.
Paul Lewis
Version 1.21 errors corrected and brought up to date with latest inflation (April 2025)
22 May 2025
