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Cash and bonds are different investments

Photo of different round fruits to illustrate to how cash and bonds look similar but are different.

A mistake even experienced investors make is to think of bonds and cash as identical.

Bonds are not the same as cash. Confusing the two is a bit like mixing up a bicycle with a unicycle. Yes, both have wheels. But one will give you a much smoother ride than the other.

For instance I once heard David Kuo, then head of personal finance at The Motley Fool UK and a frequent radio personality, mix up cash and bonds in a (now deleted) podcast.

Quoth Kuo to his guest:

“Do you buy into that rule of thumb that says that you express your age as a percentage, and that should be the amount of your portfolio allocated to cash? So somebody who is 20 years of age should have 20% of their portfolio in cash, a 30-year-old should have 30%, and so on and so forth?”

But as we’ve previously explained, the rule of thumb is to hold your age as bonds – not cash.

Similar idea, but potentially very different in practice.

This is not to pick on Kuo. I’m sure it was just an honest slip and Monevator is hardly not error-free. But I think it was telling mistake.

The fund manager Kuo was interviewing later pointed out the flaw in substituting cash for bonds:

“I wouldn’t necessarily say cash either, cash has not generated such good returns as fixed interest over the very long term, so you’re better off probably suffering a liquidity risk with fixed interest investments, rather than cash.”

Here liquidity risk means the chance that your investment will be worth less than you paid for it at any particular point in time, due to the fluctuating market value of bonds.

This risk is just one of several important differences with cash.

On the other hand, as the manager says bonds have delivered higher real returns than cash over the very long-term.1. And that difference in return profile is the other crucial distinction.

So yes bonds are more volatile than cash. Sometimes gut-wrenchingly so.

That’s exactly why bonds have historically delivered superior returns.

Cash and bonds: different investments

Cash has several key attributes:

  • Cash is the least risky asset class. Cash is king!
  • Cash doesn’t fluctuate in value (except versus other currencies).
  • Cash pays a varying rate of income that shifts with market interest rates, competition between banks, and so on.
  • Cash is extremely liquid. You can typically transfer it from one person to another without any trading costs instantly. And you can withdraw it from a current account on demand.
  • There are special protections for cash savings accounts for consumers. See the Financial Services Compensation Scheme.
  • Very long-term returns from cash are poor – in the UK only about 1% ahead of inflation.

Someone may be about to say something about inflation here, and how this is a big risk of holding cash.

But inflation is an equal opportunities wealth-sapper in its ability to erode real returns.

Everything is affected when a £1 today is worth 90p next year. Cash obviously. But also a share price, say, or the value of your home.

Yes equities have been a better defence against inflation than cash – but that’s because their total returns have historically been much higher. A nominal 10% return from equities still becomes a 5% real return when inflation is at 5%, just the same as a 5% return from cash becomes 0% in real terms.

So if you have reason to hold a chunk of cash instead of buying more equities or bonds or anything else (say for safety, emergency fund, portfolio ballast, diversification) then inflation is kind of moot.

Turning to bonds:

  • Bonds fluctuate in value – the price of a bond goes up and down between its issue and its eventual redemption. This makes bonds riskier. (See my old piece on what causes bond prices to vary).
  • Bonds can default which also makes them riskier than cash. Highly-rated UK government bonds are assumed to be risk-free (because the government can always print more money) but they are still riskier than cash, which has no default risk. Corporate bonds are much riskier than cash.
  • Bonds are less liquid than cash. You’ll need to buy and sell your bonds via a broker, who will charge a fee.
  • Bonds pay a fixed interest rate (usually).
  • Bonds repay their par value on redemption (unless they default, and without getting into the complications of linkers).
  • With government bonds your protection comes down to the ability of the issuing government to meet its obligations. (And separately, any investor protections that apply to the platform you’re holding the bonds on.)
  • Very long-term returns (50 to 100 years, say) from bonds are better than cash, but timing plays a part over the short to medium term.

As you can see, quite a difference!

Confusion marketing

I understand where the confusion between cash and bonds comes from.

Private investors – especially old-school stock picker types – tend to think either ‘equities or not equities’, rather than considering cash as a separate asset class. Let alone grappling with the different types of bonds, the intricacies of duration, or other bond-nerd-o-terica.

Meanwhile institution investors moving around vast quantities of assets typically don’t have the option of going to cash for any meaningful period. Instead, when they ‘go liquid’ they typically go into short-dated government treasuries, which are ‘cash-like’ investments but are not cash.

Company reports use terms such as ‘cash-like’ or ‘near-cash’ when describing their assets, too.

It’s sometimes an appropriate shortcut to lump cash and bonds into the same – very wide – basket, but we need to remember when and why we did so, and to know when it’s definitely inappropriate.

Cashing up

The fact is you could put £10,000 into very long-dated – say 30-year – UK government bonds yielding 5% and I could put £10,000 into a bank account paying 5% and after a year your bonds could be worth almost anything – thousands of pounds more or less than you paid – while my cash would still be worth £10,000.

That’s the intrinsic risk of bonds.

Now, if you held your 3o-year bonds until they matured and we both kept spending all our income, then after 30 years you’d redeem your bonds and have the same amount of money as me: £10,000.

But if you needed to sell your bonds in-between?

Finger in the air time.

Note though that while I am ignoring income for simplicity and to make a point, over the long-term doing so is really unfair on bonds. That’s because the known-in-advance income stream from bonds is a huge component of what de-risks them as an asset class.

Thanks to the knowable elements of a bond’s future returns (the redemption value and coupon rate) you can pretty confidently approximate your long-term returns at the very moment you buy.2 Rather than it being a crapshoot like with equities, or even cash. (Interest on cash varies, whereas a bond coupon is fixed).

  • See our article on whether you should hold cash or bonds for more on this. (And remember the answer is often ‘both’!)

Horses for courses

To confuse matters in conclusion, you will sometimes hear high-falutin’ types who read Monevator (or who write it) describing cash as like a zero-duration bond.3

What they mean is that in having no maturity date, cash is like a bond that continually matures in the next micro-moment.

This mental accounting has some useful side effects. For example, it makes it obvious that one way to reduce the overall riskiness of your bond portfolio is to swap some of your bonds for cash. This reduces the average duration of your bond bucket, and hence how much it fluctuates with interest rate moves.

However as I’ve listed above, even a zero-duration bond – a bond that matures tomorrow, say, in practical terms – has a different risk profile to cash.

Sure, if I had to pick the asset most like cash – the safest, most liquid, and hence most ‘cash-like’ in the world – I’d choose very short-term US government bonds, hedged to your local currency. (And recent ratings downgrades be damned!)

The chances of you not getting your money back on those are tiny. You’d be paid an income, too.

Similarly, if you want to mix-up the non-equity holding part of your portfolio then diversifying beyond bonds into cash (or vice versa) is a logical first step.

But similar is not the same as identical. And as soon as you add any meaningful duration to the bonds in question, the differences become pretty clear.

Both cash and bonds are valuable assets precisely because they can play different roles in your portfolio. (Yes, even after the bond rout of the past 18 months.)

Cash and bonds are not the same.

  1. At least if you ignore any hard-to-calculate boost from rate tarting your money from one best buy savings account to another []
  2. The reason you can’t ‘perfectly’ calculate the future return is you don’t know what price your bonds will be trading at as you come to reinvest that income over the years. []
  3. Specifically a floating-rate bond, as the interest rate varies. []
{ 19 comments… add one }
  • 1 Hobard August 18, 2023, 7:07 pm

    The one thing that has always confused me about bonds (newbie investor here), is if we are to hold our age in bonds, is that actual bonds vs. % portfolio allocation into bond funds? If it’s the former, could we even buy bonds as retail investors? My understanding is that we don’t have much choice beyond funds? Thank you!

  • 2 The Investor August 18, 2023, 8:34 pm

    @Hobard — Most writers take it to mean bond funds — few everyday retail investors hold actual individual bonds, though it is becoming more common right now.

    What’s most important as an average investor is to consider the duration (a proxy for interest rate sensitivity, which is then a proxy for the likely volatility (downside and upside!) of your holdings.

    Owning an intermediate / short-to-medium term bond fund (duration 5-10 years) is often considered a decent compromise between risk, reward, and having some ballast in your portfolio.

    But please note this is a huge subject, and this is not personal advice (don’t know anything about you etc!)

    We’ve written tens of thousands of words of bonds accordingly. You might want to make a cup of tea and start perusing here:


  • 3 Time like infinity August 18, 2023, 8:44 pm

    @TI: “I’d choose very short-term US government bonds, hedged to your local currency”: surely though, the case for ultra short T-Bills (1-3 months) is that, in extremis, all assets, even AAA-AA gov bonds, become correlated, falling in tandem as institutions sell everything, from the riskiest to the least, to meet margin calls. In those circumstances, as goods as USD cash assets, like 30 day T-Bills, become the only truly safe one when you most need a safe asset. GBP falls v USD in such circumstances, so even £ deposits loose value versus USD; and of course, in such crisis situations, there is often concern around bank solvency, or at least liquidity. So, would you not want to leave exposure to USD unhedged?

  • 4 Risk On Risk Off August 18, 2023, 9:59 pm

    All I know is last month, I got £600 in interest in my SIPP on £180k of genuine cash (a little less than 2/5 the value of the SIPP). Equates to 4% risk free – with potential to go up. Meanwhile, look at the stocks in the SIPP over the last month, and it ain’t so pretty.

    Part of me is *very* tempted to up that cash component by selling some equities and waiting a while…of course that has it’s own risk but at this point, I rather like the ‘yield’ on the cash.

    Frankly selling up, getting 20K per year interest on the full 500k and adding my highly tax efficient 40k contribs per year into it is so tempting it makes me think why even bother complicating life further?

    Do that, and in 10 years, if things stay as they with rates it’ll exceed the old LTA. Yes, the real value of £1m will have diminished, but chances are whatever happens there’ll be a country I can eventually move to (or even stay in the UK and be frugal) and live off this pot in 10 years now, so why am I still buying VWRL and messing about with TSLA for fun?

    Especially as I have no intention to retire anyway!

  • 5 Eadweard August 18, 2023, 11:07 pm

    Do gilts really have higher default risk than UK cash? I figure its the same government that backs both of them and if said government is failing to pay its bond holders then it’s unlikely to have the money to be bailing out banks. I’ve always considered cash and gilts equally (non)risky with regard to default.

  • 6 Peter August 19, 2023, 2:13 am

    @Risk On Risk Off I like your thinking, probably because I thought the same. But I’m trying to resist the urge and stick to what Jack Boggle preached and just stay the course.

    I’m thinking how much money I am loosing by not keeping cash that pays nice interest.

    Yet, my instincts and actual knowledge suggest that sticking to equities will likely prove better investment in a long term than cash.

    I can’t afford to derisk my portfolio anyway. Congrats to you who seem like that’s an option.

  • 7 Andrew August 19, 2023, 2:18 am

    Calling cash the “least risky asset class” is controversial in my view.

    Long term studies show the real return on cash is essentially zero percent – and that’s if you’re highly motivated and move you money around to keep the banks honest, or stick to money markets. It also ignores tax (income tax is high these days compared to CGT)

    I have my entire emergency fund in high coupon (ISA sheltered) directly held 2027 gilts. Even if yields go to 10%, and something awful happens such that I need to cash in before maturity, I’ll take only a 6% haircut. The nature of bonds let you calculate these what-if scenarios precisely and take a calculated risk. The availability of bonds with many coupons and durations let me pick the bond most suitable for my purpose (maturing just before my next remortgage in my case).

    Bonds add tonnes of flexibility to a portfolio.

  • 8 Matthew August 19, 2023, 6:07 am

    Do bonds still outperform top cash savings after fund fees and platform fees?
    Also having to hold something 50+ years to be sure it’s worth it isn’t greatly compatible with lifestyling

  • 9 David J Merkel August 19, 2023, 6:14 am

    What is called “cash” is typically very short-term fixed income. Many bonds have a mini-rally when they become eligible to be bought by money market funds. PIMCO played those rallies for years; then others caught on.

    Cash and bonds are part of a continuum, and those of us that manage bonds know it. Both are needed. Bond ladders are the most durable strategy in bonds, which implies you will always have some cash-like bonds around.

  • 10 Matthew August 19, 2023, 6:22 am

    Wanted to add I think pensions create a bit of a captive market for bonds because they don’t have access to the same top cash savings alternatives for lifestyling into instead, and since they would charge the whole fees on it all anyway – with isas you’re not so cobstrained

  • 11 Time like infinity August 19, 2023, 9:47 am

    @RORO, Eadweard, Peter, Andrew #4-7: all excellent points. Worth reading Ben Carlson’s 15/8/23 piece “Why Aren’t Investors Selling Stocks to Buy Bonds” at AWOCS.

    Re: #5: Agree 99%. Central Bank of a county with own currency always just able to create money to pay the country’s sovereign debt denominated in that currency; but maybe 1% hesitation as:
    a). regime changes have led to countries repudiating all their debts however denominated (most notoriously, the 1918 rejection of all sovereign debt and other financial obligations by the Bolsheviks after the US broke off diplomatic relations in December 1917).
    b). Weird stuff happens. 25 yrs ago this month, Yeltsin defaulted on Russia’s domestic debt which Central Bank could have created rubles to continue to pay, to show foreign investors in $ assets that his gov wouldn’t take easy road of inflating away debts without defaulting (Russian interest rates raised to 150% at time).
    c). Congress claims power to stop US Treasury breaking debt ceiling even though Fed Reserve can create as many $ as it pleases to pay any amount of debt.

  • 12 ZXSpectrum48k August 19, 2023, 10:11 am

    @Matthew. Generally speaking, time deposits (such as fixed rate savings products) at banks should have a higher yield than equivalent maturity government bonds. That’s because by “saving” you are doing unsecured lending to a commercial bank with a lower credit quality than the government. FSCS protection negates that credit risk (unless the govt itself is vulnerable to default) for most smaller savers. Beyond the FSCS limit of £85k though you would have to weigh up whether the higher yield was worth the credit risk.

    “Cash” is really an continuum of different forms of lending. From physical cash in your pocket, to overnight unsecured lending to unsecured time deposits. There is also short term secured lending.

  • 13 Matthew August 19, 2023, 2:14 pm

    @zx81 – Thank you, and fscs = risk free extra return!, although you’d think fscs protection would be priced into cash savings rates or that people who do fall under fscs protection would demand more yield from bonds – as such, as it is, people are almost paying for duration – you could almost look at it as an inversion of the yield curve once fees are deducted – like people are more worried about recession than rising rates – although I think it’s probably largely from intertia/lack of awareness from pensionholders rather than a bellweather

  • 14 Brendon August 19, 2023, 3:56 pm

    > I’d choose very short-term US government bonds, hedged to your local currency

    It’s a fairly moot point, but buying anything hedged involves also buying derivatives, and that means additional counterparty risk (other than the US government). Minimal risk in the grand scheme of things, though, I guess.

  • 15 Sparschwein August 20, 2023, 11:58 pm

    Real bond yields have gone up from negative 2% or 3% to positive 2% now. That’s a huge change that I don’t see discussed much.
    It should have been rather obvious that bonds that guarantee to lose money were a rubbish deal. But the market has re-priced bonds dramatically in 2021/22 and I’m trying to wrap my head around why:
    – the bond market doesn’t believe the inflation expectations implied in, er, the bond market?
    – investors have been burned and irrationally avoid bonds now? (this may be true for some, but I think the bond market as a whole is very unlikely to be irrational)
    – compensation for the increased uncertainty of future inflation?
    – compensation for the increased risk of default, due to higher debt levels and higher interest payments?

    The latter point is one to consider in a retirement portfolio. US debt-ceiling crisis, UK mini-budget and moron premium, the Greek debt crisis… I’d want to be diversified enough to watch the next instalment without worrying if I’ll be able to put food on the table.

  • 16 The Investor August 21, 2023, 8:00 am

    @Sparschewein — You write:

    Real bond yields have gone up from negative 2% or 3% to positive 2% now. That’s a huge change that I don’t see discussed much.

    As a regular commentator I’m sure you’ve seen my several posts on this subject over the past year, but here are three in case you missed them, in reverse date order:


    https://monevator.com/index-linked-gilts/ [Mogul members-only]


  • 17 Time like infinity August 21, 2023, 2:22 pm

    Three superb articles there @TI. A lot to think through.

    – Is the lesson of the bond crash that things are looking a lot better now for bond holders and annuitants?
    – Or is that the discount rate to growthy assets like tech has gone too high (or has gone, or is going, back to normal)?
    – Or is it that the income benefits of Value / High Divi Yield are being obscured by the high risk free rate?

    The absolute slaughter in the profitless tech unicorn (unlisted VC and SPAC) space makes sense when considering the risk free rate to be the gravity of investing. Higher current risk free rates must increase the collective expectation for the appropriate discount rate applying to earnings which may only arise, if they do at all, well into the future.

    Also, rates now mean higher current borrowing costs for fledglings, and thus a higher burn rate of private market investor capital (the NASDAQ bubble burst in March 2000 just as Barrons put out a negative piece on the burn rates of then tech darlings. Obviously, chronology is not causation, but it was an interesting coincidence).

    For High Divi Yield, the problem for asset values is, contrastingly, in the here and now, as there are alternatives (for the first time in many years) for income seekers, including much higher risk free rates in short term gilts and T-Bills, as well as on cash deposits.

    Clearly, in many areas of the markets, the sales are now on; but as always in these situations, the difficulty lies in identifying in advance what is a real bargain from what is just a value trap.

    Are the bargains in listed PE trusts on 30-40% discounts to NAV, or in growthy tech and multi asset trusts on 20% off, or in infrastructure trusts on 10-20% off NAV, or in listed trading shops like BH Macro at 5-10% off; or is it in lower risk assets like long and intermediate (conventional or IL) bonds at nominal and real yields of about 4-5% and 1-1.5% respectively, or is it in more cash like instruments, like short bonds? No one can ever know the answer, except in retrospect.

  • 18 SemiPassive August 21, 2023, 4:35 pm

    Time like infinity, I do wonder how much things like infrastructure trusts being whacked (some on 20%-30%discounts yielding 6.5-7%+) is due to investors choosing gilts and corporate bonds instead for a similar return with less risk as opposed to shunning them for fear of borrowing costs for the trusts increasing to a level where they make less profit and cannot sustain or increase dividends. It is probably some of each.

    The whole reason you pick high dividend equity & things like infrastructure trusts over bonds is that the value and yield is supposed to increase gradually over time with inflation. Although my personal experience with such trusts and ETFs that I hold is that this may only be the case over very long timeframes, and only if you pick the right ones. Not always easy to know in advance.
    Many have been disappointing to the point where I can see myself adding a significant asset allocation to gilts and corporate bonds given the current yields. They are where I see most value for money, certainly when you take risk and valuations into account. Although my age is such that I’m overdue increasing my allocation to bonds anyway. What’s not to like when they yield more than the FTSE100.
    I’m just looking at gilt yields now on marketwatch.com, what a great time to build a ladder and face zero chance of a nominal loss and a decent chance of beating inflation for the first time in years.
    I wonder if we will soon see every gilt maturity at 5% or more, certainly from 1 yr to 30 yrs.

  • 19 Time like infinity August 21, 2023, 11:57 pm

    Thanks @SemiPassive. You’ve got really excellent points. There must be a very significant premium which should be commanded for the near certainty for investors of getting both return of their capital and a guaranteed level of income from either gilts or from hedged to sterling foreign developed market high quality sovereign debt. Not at all keen on CBs though. There would have to be really quite a large spread over the rate offered by AAA to AA sovereign debt to make it worth taking on the extra risks, especially as with CBs you don’t get a ‘participation’ upside, as you do with equities.

    Conventional Gilts, ILGs, T-Bills and TIPS are in a class of their own quality wise. Although I am fairly confident that global equities will substantially outperform them on a 30 year view, the ride will be far smoother and more predictable with the gilt option than with the equity one, even if is quite likely to be significantly less rewarding return wise.

    Looking at the infrastructure trusts, you are quite right. Discounts today range from an eye watering 27% for HICL, through 19% for TRIG, down to 11% for 3i. None quite as bad though as 39% discount for HarbourVest in my PE allocation (which is basically where it was when I brought it earlier this year).

    I guess the market just doesn’t buy the asset values and, for the infrastructure trusts, is terrified of the costs of upgrading and repair (Thames Water’s appalling situation being a particularly striking case in point).

    One thing that I will not be touching unless and only when discounts move to truly extraordinary levels (i.e. 50% or more) is ordinary commercial property trusts. When I go into work I see offices left, right and centre which are at least two thirds empty on Fridays and Mondays and only reaching maybe half to two thirds full on the busiest day, Thursdays. Local café to office saying at lunch today that it’s barely worth their while now opening on Mondays and Fridays, whereas before 2020 it was packed with trade all 5 week days. Firms can’t ditch the long (20-25 year) office leases right now but, as they come up for renewal or break clauses, I can see that most firms will substantially downsize their footprints to save big on their costs. The carnage that this will then cause to commercial property values has not yet worked its way fully into the market pricing of the trusts operating in the sector.

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