Like most investors, I am very keen to make my money work hard for me. Inflation here in the UK is currently around 1.5% and has averaged around 2% this year. This means that I need to make at least 1.5% a year in order to break even and not have the value of my money eroded by rises in the general price level.
An easy way for many people to counteract some inflation is to simply put their money into a Cash ISA. Firstly, the ISA does not attract tax, meaning that you can keep more of the interest for yourself, without losing some to Her Majesty’s Government (thank you ma’am).
Secondly, locking up your money in a Cash ISA takes minimal effort on your part, with rates between 1%-2%. This means that while you may still be worse off having a Cash ISA versus inflation, it absorbs some of the cost of doing nothing.
What about Lloyds?
Here comes the other side of the coin. If you invested in Lloyds Banking Group (LSE: LLOY) at the current share price, you would be picking up a dividend yield of 5.33%. Not only would you offset the 1.5% inflation rate, but you would easily beat the best Cash ISA rates in the market at the moment.
So yes, investing in Lloyds would give you a higher yield than a Cash ISA. But there is a key point to note.
A Cash ISA does not have any volatility or create uncertainty around your capital. Even if your ISA provider goes bust, you could still get back the amount you invested. Contrast this to investing in Lloyds, whereby you hold actual stock in the company, which fluctuates in value every day.
If you had invested in Lloyds a year ago, you would have seen your capital grow by 9.2% as of market close last Friday. From that point of view, it is a bonus on top of any income you received via dividend payouts. But what about the volatility over the past year?
The ‘maximum drawdown figure’ is a number some investors use to evaluate the volatility of a stock. It measures the difference in price from the high to the low during the period specified. You can hopefully see where I am going here — if Lloyds has a large drawdown number, then the additional risk we are taking on by investing in it will not offset the additional yield pickup of 3.33% we get.
After running the numbers, the maximum drawdown for Lloyds over the past year is around 27%. For comparison, HSBC has a max drawdown of 19% and Barclays has 22%. On the flip side, the highest dividend yield stock in the FTSE 100 (Evraz) has a max drawdown of 50%!
It all means Lloyds does have relatively high volatility when you compare it to some banking peers in the FTSE 100, but it is not as volatile as other stocks in the index.
Each investor can make his own call as to whether the risk of a fluctuating stock is worth the higher yield. But based on the fact that Lloyds’ maximum drawdown figure is in line with the industry, and Cash ISA rewards are so low, I would feel comfortable owning the stock and picking up the dividend yield.
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Jonathan Smith owns shares in Lloyds. The Motley Fool UK has recommended Barclays, HSBC Holdings, and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.