Risk vs Reward
You never know when you might need cash. But keeping it in a savings account can lose you money over the longer term.
If you’ve been taping cash to the back of your toilet tank like Joey in Friends, it’s time to reconsider your long-term strategy.
The one certainty is that the future is uncertain, whether politically - Brexit springs to mind – or just your own personal future, and you never know when you might need cash. But keeping it under your mattress or in a savings account can actually lose you money over the longer term. This is because inflation is rising in the UK and when inflation rises, the cost of goods and services goes up, but your money doesn’t – so what you can afford to buy becomes less.
As of June 2018, inflation is 2.4%, higher than the Bank of England’s 2% target1.. Most UK savings accounts will give you less than 2% interest2. This doesn’t mean we should put all of our worldly assets into an investment portfolio – after all, financial advisers usually recommend their clients hold a cash buffer for emergencies or a rainy day. But it might mean considering investing in addition to holding cash.
Like many important things in life, there is never a perfect time to make a first investment – it comes down to how much you can afford to part with and when you feel you are sufficiently informed. And you don’t just have to pay in a lump sum and forget about it – you can actively invest in your future by making a regular contribution to a Stocks and Shares ISA, for example, with a direct debit.
And the secret is that when everyone else is running away as fast as they can from the stock markets when they are down, the experts are swooping in, picking up bargains that they hope will regain value. Stocks usually go up over the long term, although there is no guarantee. For example, the MSCI World Index, which charts the combined performance of a very large basket of companies from around the world, is up around 124% since October 20093 despite several dips on the way up. And yes, that’s since the financial crash of 2008 and markets have generally been on the up for the past decade. But even taking the crash into account, the FTSE 100, a measure of the 100 largest companies in the UK, has returned more than 600% since the 1980s4..
While the evidence shows that investments can make a higher return than cash, investors must also be prepared to lose money, especially if they are not invested for the long term.
As investors gain knowledge and confidence, they might branch out from holding a diversified portfolio of, say, UK and US companies, to include more volatile sectors like emerging markets. The risk doesn’t go away just because you have experience, but experienced investors know that the higher the risk, the higher the potential returns.
1 Bank of England, 23 July 2018 2 Money.co.uk 3 Yahoo Finance, 23 July 2018 4 Google Finance, 23 July 2018