Why we need to invest, as well as save, for the future
Having cash savings to cover emergencies is important. But for the longer term any cash you hold will be eroded in real terms by inflation and therefore it’s important you also consider investing. School fees? University costs? More for your retirement? You should invest.
Sometimes, life can take us by surprise – and not in a good way. Whether it’s a leaky pipe, a broken down washing machine or an emergency trip to visit an ill relative, most of us turn to our short-term savings when we’re in crisis.
Having a rainy day fund is essential, it allows you to quickly access cash when you need it without having to borrow money at an extortionate rate. And savings are also there for you in the good times, helping you to build up funds in the short term so you can take that dream holiday.
Set your target and invest
But what about the long term? What can we do to give our children the best possible start in life? How will we pay for their university education or wedding? And how can we ensure we enjoy our own retirement?
If we want to achieve our biggest dreams in life, saving money into a bank or building society just won’t cut the mustard. Interest on savings has dwindled in the last 20 years, with the average rate now standing at just 0.13% according to The Money Charity.
This means that savers are actually losing money in the long term, as rates fail to keep up with inflation which has risen to above 2.0%. This combination of low interest rates and high inflation means the real value of your cash is being steadily eroded over time, with only a handful of accounts keeping up with, never mind beating, the Consumer Price Index (CPI) measure of inflation.
Stocks have historically outperformed cash long-term
By contrast, the stock market offers a very real opportunity to beat both cash rates and inflation — as long as you are invested for the long term. This is the only way you will see out the peaks and troughs of the stock market, with the best chance of ending your investment on a high. For instance, putting £1,000 into a cash ISA when it first launched in 1999 would have earned £204 in interest by today. Investing that same £1,000 in the UK stock market over the same period would have returned £1,663 - 38% more - despite going through the dotcom bust in the early 2000s and the financial crash in 2008, one of the worst stock market downturns in history.
James Rainbow of Schroders UK, which published this information, said: ‘The data we have provided adds to an existing body of evidence that shows the stock market tends to grow your money far faster than savings accounts over longer timeframes.’
And this is key. Most of us will need a combination of savings to meet our more immediate financial needs and investments to reach our long-standing goals. Your strategy will depend on how long you have, and you need to bear in mind that your investments will go up as well as down, you may not get back what you put in and the past is not always a dependable guide to the future.
If you’re aiming to buy a house or a new car, your timeframe is likely to be five years or less, so in this case, you are better off saving rather than subjecting yourself to the risk of a short-term stock market crash with no time to regain your losses and make returns in a future market upturn.
Invest for the medium to long-term
If you have a medium-term horizon to work with (possibly because you’re saving for school fees over five to ten years), you have enough time to get something back from investing. Longer term, you can afford to take more risk by having a greater investment in equities, which can be a rollercoaster ride but have historically outperformed other asset classes (including cash). This is crucial when you consider the cost of life’s major milestones today.
Rising university fees, increasingly unaffordable housing and weddings typically costing between £10,000 and £20,000, which means we need all the financial help we can get. This, combined with pressures on the state pension and warnings about inadequate contributions into workplace schemes, means we’ve got to make our own provisions for the future.
So while there are no guarantees when it comes to the stock market, one thing is for certain — when it comes to long-term capital growth, we’ve got to be in it.