Shares Vs Cash: Where Should You Invest Your Money?

Deciding whether to invest in shares or retain cash is a tricky decision that requires a careful assessment of various factors. While investing in shares offers the potential for higher returns and diversification, it also carries higher risks and may require more active management. On the other hand, holding cash provides stability, liquidity, and protection against market downturns but may result in lower returns over the long term. Ultimately, the decision depends on an individual's financial goals, risk tolerance, time horizon, and personal circumstances.

Pros and cons of investing in shares

Pros of investing in shares

• You are in control of which shares you buy, where, and how many.
• Shares are easy to trade, as public stock markets are open most of the working day.
• You can better control your capital gains tax liabilities.
• Shareholders may receive regular dividend payments from the companies.
• There are lower fees, as you don't have to pay the annual fees associated with investing in funds.
• There is potential for huge gains. Because your investment is concentrated in one company, if its share price rockets, you will likely make more money than if you had a spread of investments in a fund.

Cons of investing in shares

• There is potential for huge losses. Because your investment is concentrated in one company, if its share price collapses due to a corporate scandal, economic hit, or poor performance, you will lose money.
• It is challenging to achieve true diversification, as you need to buy shares in a range of companies and sectors.
• Investing in shares can be time-consuming, as you need to commit a lot of time to researching companies and sectors, learning to read financial reports, judging future economic trends, and following the markets.
• You need to consider the cost of fees associated with the buying and selling of shares and any broker commissions.
• Share prices can be volatile, rising and falling steeply in line with company performance and the markets.

Pros of investing in funds

• Diversification: By having a wider spread of shares or assets or themes in a fund, if the share price of one of the firms in your fund performs poorly, your money could be better protected thanks to gains elsewhere in the fund.
• Professional management: Fund managers are experienced stock pickers and often have large research departments providing them with up-to-date analysis and information.
• There are no trading fees, as you are not doing the physical buying and selling of shares.
• Investing in funds is less stressful, as you don't have to spend all your waking and sleeping hours worrying about share prices.
• You need to do less research, as you are still researching individual funds rather than individual shares.
• You may receive a regular investment income from some funds in the form of a distribution.

Cons of investing in funds

• Your investment choices are out of your hands, as it is the fund manager who makes the stock picks and creates the investment portfolio and theme.
• There are costs to cover the day-to-day running of the fund.
• Tax efficiency is reduced, as you don't have control over when fund distributions are paid into your account, making it harder to be tax-efficient.
• There are trading restrictions, as mutual funds are only traded once a day near the close of markets.
• Selection risks: The price can go up or down depending on the strength or weakness of the index, asset, or sector the ETF is tracking.

Pros and cons of investing in funds

There are several types of funds an investor can choose to invest in, such as mutual funds, lifecycle funds, and money market funds. Here are some pros and cons of investing in funds:

Pros

• Advanced portfolio management: Funds are managed by professionals who buy and sell stocks, bonds, etc. This is a relatively small price to pay for getting professional help in managing an investment portfolio.
• Dividend reinvestment: Dividends and other interest income sources can be used to purchase additional shares in the fund, helping your investment grow.
• Risk reduction: Most funds will invest in a diverse range of securities, reducing the overall risk of the investment portfolio.
• Convenience and fair pricing: Funds are easy to buy and understand, with low minimum investments. They are traded once per day at the closing net asset value (NAV), eliminating price fluctuations throughout the day.
• Easy diversification: Funds allow investors to buy shares in many different securities at once, providing a simple way to build a diverse portfolio.
• Professional management: Fund investors don't need to worry about rebalancing their portfolio or buying shares at the right time, as this is handled by the fund's management team.
• Liquidity: Shares in mutual funds can be bought and sold easily, making them a liquid investment.
• Variety of options: There are thousands of funds available, each with its own investment strategy, allowing investors to find one that fits their needs.
• Low cost: Many funds charge relatively low fees and have low minimum balance requirements, making them one of the lowest-cost ways to invest in a large portfolio of securities.

Cons

• High fees: Funds charge various fees for the services they provide, which can include high expense ratios, sales charges, and management fees. These fees reduce overall investment returns.
• Tax inefficiency: Investors typically receive distributions from the fund that are an uncontrollable tax event, making it harder to use tax-minimizing strategies.
• Poor trade execution: Funds provide a weak execution strategy for investors looking for faster execution times due to short investment horizons or day trading.
• Less control over your portfolio: Fund investors rely on the fund manager to construct the portfolio, and may not be able to invest more in a specific sector or stock unless they buy shares in a fund that focuses on that area.
• Capital gains taxes: Mutual funds need to distribute capital gains regularly, and investors have less control over when they pay capital gains taxes.
• Cash drag: Mutual funds need to keep some cash on hand, which can slightly impact returns compared to investing 100% of the money in the market.

Risk factors

There are several risk factors to consider when deciding whether to invest in shares or cash. Here are some key points to keep in mind:

• Volatility: The stock market is subject to volatility, with periods of ups and downs, bull runs, and bear slumps. High volatility can cause investors to panic-sell. It's important to monitor stock volatility, which can be challenging for some investors to handle on a daily basis.
• Interest Rates: Monetary policy and interest rates can significantly impact the market. Low-interest rates can stimulate borrowing and economic growth, while higher rates encourage saving. However, low rates may result in lower returns for savings accounts and fixed-income investments. It's crucial to consider how interest rates may affect your investment choices.
• Corporate Profitability: Corporate profits can directly impact stock prices. While companies have generated strong profits in recent years, the pandemic, lingering effects, and geopolitical instability could impact corporate profits in the coming quarters and years, potentially leading to lower stock prices over the long term.
• Inflation: Holding cash comes with the risk of inflation eroding the value of your money over time. In an inflationary environment, the buying power of your cash holdings may deteriorate, affecting your overall returns.
• Diversification: Investing in a diverse range of assets can help manage risk. Putting all your money into a single type of investment, such as cash or individual stocks, is risky. Diversifying your portfolio across different investments can reduce the impact of any single investment performing poorly.
• Time Horizon: Your investment time horizon is crucial when deciding between shares and cash. If you have a long-term investment horizon, such as retirement planning, investing in shares may be more suitable. On the other hand, if you are saving for a short-term goal (less than five years), investing in cash or more conservative options may be preferable.
• Risk Tolerance: Consider your risk tolerance when deciding between shares and cash. Shares tend to be riskier, especially if you invest in individual stocks. If you are prone to panic-selling during market downturns, you may want to invest more conservatively and consider cash or less volatile investments.
• Fees and Costs: Investing in shares may involve trading fees, broker commissions, and other costs associated with buying and selling. Funds also have management fees and ongoing charges, which can impact your overall returns. It's important to understand the fee structure for any investment option you consider.
• Tax Efficiency: Shares offer more control over capital gains tax liabilities as you decide when to buy and sell. However, funds provide tax advantages through vehicles like ISAs and pensions, which can protect your returns from income and capital gains taxes.
• Liquidity: Cash provides high liquidity, allowing easy access to your funds. Shares may be less liquid, especially if you invest in individual stocks, as selling them may take time and impact the price.

Ultimately, the decision to invest in shares or cash depends on your risk tolerance, investment goals, time horizon, and financial situation. It may be beneficial to seek advice from a financial professional to help you make an informed decision that aligns with your specific circumstances.

Current market conditions

The current market conditions are mixed, with some analysts predicting a rocky year for investing in 2023, while others suggest that holding cash will be a winning strategy. The failures of Silicon Valley Bank and Signature Bank have recently spooked investors and sent stocks lower. However, the markets had moved upwards by midday the following Monday, indicating a level of resilience.

Cash has become a more attractive option for investors, with some certificates of deposit paying over 4% interest, while stocks remain vulnerable to losses. The federal funds rate is at its highest level in 15 years, and the Fed plans further interest rate hikes in 2023, making cash a more appealing prospect. Some savings accounts now offer attractive yields, with some banks paying over 4% interest.

However, it's important to consider the potential downsides of holding cash. Firstly, cash is historically a drag on investment returns, and trying to time the market rarely pays off for long-term investors. Secondly, reinvestment risk is a concern, as investors holding cash may face lower interest rates when it comes time to reinvest their funds.

Overall, the current market conditions present a mixed picture, with volatility expected in 2023. While holding cash may provide a temporary safe haven, it is not a long-term wealth-building strategy, and investors should carefully consider their objectives and risk tolerance before making any decisions.

Long-term vs short-term goals

When deciding whether to invest in shares or cash, it's important to consider your long-term and short-term goals. Here are some key points to keep in mind:

Long-term goals:

• Stocks are ideal for long-term wealth accumulation: Historically, the stock market has provided an average annual return of about 10%, making it one of the best ways to grow your money over time. If you're investing for retirement or other long-term goals, stocks are a good option.
• Stocks offer the potential for higher returns: While there is a risk of losing money, investing in individual stocks can lead to significant gains if the company performs well. This is known as having a higher risk-reward profile.
• Funds are more suitable for a buy-and-hold strategy: If you're a long-term investor who wants to avoid the hassle of active trading, funds are a better option. You can invest in a diversified portfolio of stocks or other assets through mutual funds or exchange-traded funds (ETFs).
• Funds provide professional management: Fund managers are experienced in picking stocks and have access to extensive research. This can be beneficial if you don't have the time or expertise to actively manage your investments.

Short-term goals:

• Cash investments offer stability and liquidity: If you're saving for a short-term goal or need emergency funds, cash investments such as savings accounts or money market funds provide easy access to your money without the risk of market fluctuations.
• Cash investments can be tax-efficient: In some cases, interest earned on cash investments may be tax-exempt or tax-deferred, such as in tax-advantaged accounts like Individual Retirement Accounts (IRAs) or cash ISAs.
• Cash is a lower-risk option: While the potential for high returns is lower, cash investments protect your principal and provide stable, guaranteed returns, especially in high-interest rate environments.
• Cash is suitable for conservative investors: If you have a low-risk tolerance or are uncomfortable with market volatility, cash investments can provide peace of mind and help you avoid panic-selling during market downturns.

In summary, when considering long-term vs. short-term goals, stocks are generally more suitable for long-term wealth accumulation and offer higher potential returns, while cash investments provide stability, liquidity, and lower risk for short-term goals. However, keep in mind that every individual's situation is unique, and it's essential to carefully evaluate your financial goals, risk tolerance, and investment horizon before making any investment decisions.

Frequently asked questions