High deposit rates, but the case for equities is strong

Investors can currently lock in attractive term deposit rates, however equities are still likely to outperform cash over the longer term.

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Australia’s headline inflation rate is trending lower as higher interest rates continue to dampen consumer demand.

That’s positive news for the economy, although getting inflation down to the Reserve Bank’s 2-3% target band could still take at least another 12 months.

While the RBA has kept rates on hold for now, Vanguard expects inflation will remain sticky. As such, it’s still likely the RBA will need to raise the cash rate one or two more times to ensure inflation returns to the target range.

While the lower July consumer price index indicator reading is welcome, it's unlikely interest rates will come down until the RBA is confident inflation will return to target in a reasonable time frame. That will be disappointing for many borrowers.

However, as we’ve already seen over the past 16 months or so, higher interest rates also naturally translate into higher investment yields from cash securities including term deposit accounts.

Term deposit rates are now more attractive than we’ve seen in many years. In fact, investors are able to lock in 12-month fixed yield returns above 5% with a range of financial institutions. That’s close to the total return from the broad Australian share market on a year-to-date basis.

This dynamic may be alluring enough to deter some investors from investing into the share market, where returns are much more variable and subject to greater volatility than cash.

Yet it’s important to consider whether holding lots of cash makes sense as part of your long-term investment plan. This will depend on your investment horizon and risk appetite.

Cash versus equities returns

The role of cash is typically to earn a return while providing liquidity for daily expenses or emergencies. It is a relatively low-risk investment, unlike equities.

The recently released 2023 Vanguard Index Chart shows that cash investments returned an average of 4.2% per annum over the last three decades.

Based on the RBA’s cash rate, if someone had invested $10,000 in cash on 1 July 1993 and left it there for 30 years, their balance would have grown to $34,737 by 30 June 2023.

Yet, despite ongoing share market volatility over the same period of time and major market downturns emanating from events such as the 2000 Dot.com crash, the Global Financial Crisis and the COVID-19 pandemic, equity markets have delivered higher long-term returns.

With an average total annual return of 10%, a $10,000 investment in the top 500 U.S. companies at 1 July 1993, when measured by the S&P 500 Total Return Index (in Australians dollars), would have grown to $176,155 by 30 June 2023. That’s excluding fees but without making any additional investments other than reinvesting all the income distributions received over time.

If invested into international shares over the same 30-year period, $10,000 would have risen to $87,584. This is based on the 7.5% average annual return of the MSCI World ex-Australia Net Total Return Index over the same period.

A $10,000 investment in the Australian share market over the same time period, when measured by the S&P/ASX All Ordinaries Total Return Index, would have increased to $138,778 based on the same strategy of reinvesting all the income distributions. That represents a 9.2% per annum average annual return over the 30-year period.

The longer-term outlook

There have been historical periods where cash has outperformed equities. This generally coincided with periods of surprisingly strong levels of inflation and high interest rates, including some years during in the 1970s and 80s, and during 2022. However, Vanguard doesn’t expect this type of environment to persist in the future.

Indeed, Vanguard expects equities to outperform cash over the long run. Over the next 10 years our median nominal return expectation for global equities is 5-7% annualised versus 3-4% annualised for cash.

Investors may be tempted to invest in cash right now given higher interest rates and then wait for the right moment to shift back to equities.

The challenge is to know when “the right time” is to move into equities and not miss out on gains in the share market in the meantime.

It is important to have a long-term investment plan, and to set your asset allocation accordingly. Time in the market is better than trying to time the market.

An iteration of this article was published in The Australian Financial Review.

 

 

 

Alexis Gray, Senior Economist, Vanguard Asia-Pacific
September 2023
vanguard.com.au

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Sofie Korac is an Authorised Representative (No. 400164) of Prudentia Financial Planning Pty Ltd, AFSL 544118 and a member of the Association of Financial Advisers.

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