‘Capital at risk’, this is a disclaimer that you’ll see across investment company websites and on many of the adverts that you see. The idea is that as a customer you understand that you take on volatility risk when you invest and the value of your investment will fluctuate.
But when you save in a cash account there’s no such disclaimer, seemingly there’s no risk. But if the interest rate is low then the ‘real’ value of your money is at risk.
That ‘real’ value of your money is based on how much you can buy with that money. In other words, inflation. Today a loaf of bread costs around £1, but if next year that same loaf of bread cost £1.06; that £100 you saved for bread over the year would buy you 94 loaves instead of 100.
When you’re saving, putting money away for a rainy day, building a nest egg, you’re doing that with the intention of being able to buy something in the future. Be that a car, a house, or even your daily groceries in retirement. If inflation is higher than your interest rate, then you are less likely to be able to afford what it is you were saving for.
Currently inflation is low, 0.6%, so it is easy to overlook its impact. But according to data from the Bank of England the average rate of inflation over the last 20 years has been 2.6% per year. Currently the top rate offered on a cash ISA, according to Money Saving Expert, is 1.7%; that looks OK with 0.6% inflation, but with 2.6% inflation the real value of your savings would decrease.
When investing you’re likely to see the value go down as well as up. As global investors flock to invest in the FTSE 100 when the value of sterling is low your UK equity investment will increase in value, but when more oil is produced than what is needed the value of your commodity investment will go down. These are the realities that investors face every day, and these changes dominate the headlines.
When you look at your investment portfolio you’ll see the value change day-by-day. Up 0.2% on a Monday, down by 0.1% on a Tuesday. This is volatility, a risk that portfolio managers work to control but it is an inevitable part of investing. This risk is much more obvious than inflation risk, but what is the real risk?
Avoid the loss of ‘real’ value
Risk for savers and investors everywhere is the loss of real value. You want to ensure that what you put away today is worth something in the future, therefore the benchmark that all of us should constantly strive to beat is inflation.
Whilst you might see daily fluctuations in your investment portfolio, fluctuations that you won’t see in cash savings, the Barclays Equity Guilt Survey suggests that you have a 75% chance of an investment outperforming cash over a five-year period. With interest rates at a record low the real risk of saving and investing has never been more real.