There is a common misconception that investing is a luxury for the rich. This basic fallacy can deter many ordinary savers from looking to the markets to help improve their financial wellness in the long run. Although this is a myth and investing is as accessible as ever, many savers are still opting to hold their wealth in cash.
For those wanting to keep their money safe, cash is traditionally the place to keep it. Whether it’s in a cash ISA, under a mattress, or in a piggy bank, avoiding the fluctuations of the stock market is still a comfort for many. But cash isn’t as safe as it once was.
Is cash safe?
There was a time that your money could earn a decent return just sitting in a cash ISA – those days are over. Interest rates have slumped to historic lows, with the current base rate sitting at 0.1%. Inflation, though not remarkably high, is projected to be at 1.19% for 2020. Essentially, your money is going to have less purchasing power in the future.
For example, if you put £5,000 into a cash ISA with a base rate of 0.1%, you’ll have £5,005 at the end of the year. But that £5,005 will be worth £4945.44 in 12 months’ time anyway, thanks to inflation. If your returns aren’t matching inflation, you’re effectively losing money.
To illustrate this point, we looked at four different hypothetical investment accounts. One was a cash ISA, while the other three were made up of different asset classes but broadly they were ‘stocks and shares ISAs‘. Across a 10-year period, we found that the difference in prospective returns for investment accounts of these differing types was enormous. For the full breakdown and to see the figures in their entirety, take a look at our blog post from earlier this year.
Why should I invest?
Investing offers savers an opportunity to generate inflation-beating returns – although the value of investments can go both up and down, of course.
People have different savings goals; whilst some want to save up to fund their travels, others want to get on the housing ladder, get married, or build up their retirement pot – the list goes on.
Someone saving for a holiday might want their money sooner than someone who’s planning to buy a house or investing into their pension, these different time horizons carry different risk levels.
Despite its negative connotations, risk isn’t always a bad thing. Investments work by balancing risk and reward; typically, the higher the risk the higher the potential return, but also the losses.
Understanding your risk level means your portfolio has the best chance of achieving your long-term investment goals. If you’re a few years away from retirement, your portfolio will have more assets that are typically seen as ‘safer’ – like bonds. Someone who is 20 and saving for retirement will be inclined to take on more risk because short-term losses are unlikely to matter in 40-or-so years.
How much do I need to start investing?
The more you can save for your future, the better. But you don’t need a small fortune to get your money to work harder for you. Whether a small inheritance is sitting in your savings account or a pay rise has left you with a little (or a lot) more at the end of the month, you can invest this straight away.
A Moneyfarm investment account, for example, works best for those with £5,000 upwards. While not a requirement to see good returns, having around this amount as a foundation for investing helps our clients get the most out of our asset allocation strategy. Anyone with savings that are in excess or close to this amount should be considering investing already! As we already mentioned, the difference in returns over the medium to long term between cash and an investment portfolio is potentially staggering.
How often should I invest?
To generate meaningful investment returns, investors want to buy at the low and sell at the high. The only problem with this strategy is that it’s incredibly challenging for an investor to do correctly every time – investors need to have the time to monitor the markets, the skill to respond to any opportunities and the money to fund the frequent trading. Many have paid the price for thinking they can beat the market.
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Instead, investors should take a risk-adjusted approach; pound cost averaging. This little and often regular investing approach prevents investors from trading on sentiment and smooths out the fluctuation of an asset’s price over time. This is a much more flexible approach to investing than committing all your capital at once.
You may also generate higher returns than if they were timing the market. For example, an investor that had invested in the S&P index between 1994-2014 would have generated a 9.85% annualised return. If they’d missed the 10 best performing days, the investor would have made just 6.1%, research from asset manager JP Morgan shows.
Can I access my cash in an emergency?
Long-term investing doesn’t have to mean locking your cash up for years to come. If you’re saving for a rainy day, you need to know you can access your investments when the stormy clouds gather above. Even if you’re certain you won’t need to access your cash for a number of years, life has a habit of surprising us.
Whilst investors can easily access their money within five working days on investment platforms like Moneyfarm, some products, like the Lifetime ISA, aim to lock your cash away to be spent on certain life events. If you need to make an urgent withdrawal that’s not buying your first home or for retirement, you’ll be penalised. As a result, Moneyfarm does not currently offer a Lifetime ISA in favour of products that give investors far greater flexibility.
How can I reduce risk?
One way to reduce portfolio risk is to diversify your investments. Achieving a diversification level that doesn’t weigh on your returns, but accurately reflects your risk levels requires cash, however, and quite a lot of it.
As managing your own portfolio of stocks and shares can eat into your finances and time, collective investments are a popular option for those wanting a slice of the diversity pie.
Known for being low-cost and transparent, exchange-traded funds (ETFs) are an increasingly popular option for investors wanting diversity. They offer exposure to markets by tracking an index or group of investments.
Ultimately, though, risk is not a negative thing in the case of long-term financial investment. In the short-term, fluctuations to a portfolio’s value could be damaging for a saver but, over the course of a decade, risk is the thing that generates the returns. If you really want to see powerful returns over an extended period of time, it pays to stop seeing risk as a scary thing. See it instead as the thing that drives your returns.
Where to invest to get good returns
Of course, everyone goes into investing for the returns. You can have preferences around what you invest in and how – you may want to make ethical choices with your money, for example – but ultimately making money is the name of the game here. When thinking about how to invest money, the amount you want that pot to grow is always going to be a decisive factor.
This is where wealth managers can really help you. Personal investing is fine for those with a background in finance or a deep knowledge of investing, while some people without imminent financial concerns enjoy the process of winning and losing with their choices. For most people, though, having an expert in charge of their wealth is important.
Digital wealth managers like Moneyfarm combine the service of a traditional wealth manager with the flexibility, visibility and control that only digital offerings can. We have a full team of asset allocation specialists, backed by a team of qualified investment advisors, on hand to help our clients best manage their wealth.
When a lot of people hear ‘digital wealth manager’, they assume that our service is automated. While we do use sophisticated technology to regularly monitor the health of our investment portfolios, it’s the people managing them and making the important decisions that set our service apart.
How to invest my money
In this current climate, it doesn’t pay to keep your money in cash. Chances are you’re thinking that now is the time to make your money work harder for you. Make sure you can answer these five key questions before you start:
- What am I saving for?
- When do I expect to access my money?
- How much can I afford to invest each month?
- What is my risk profile?
- How am I going to reduce risk through my investment strategy?