It’s generally good practice to think of your savings and investments within three distinct categories:
- short-term – less than 5 years (emergencies, holidays and other short term goals less than 5 years away)
- medium-term (school fees, university funding and other goals between 5 years and retirement)
- long-term (retirement spending)
Why? Well, quite simply, anything in the short-term category should be kept safe in the best savings account you can find. For everything else you should be investing it.
To build your wealth in the past, most people headed to their bank or building society. They would look at the different types of savings accounts available and then choose the one they preferred. They could do this knowing that their pension was taken care of by their employer, usually a final salary scheme. This is a pension that pays you a guaranteed salary at a pre-determined age i.e. 60 or 65.
Bank savings accounts sound like a great idea. You put your money away and then access it when you need it. But bank accounts aren’t all they are cracked up to be when it comes to value for money. The amount of cash in the account is, in theory, meant to grow over time with compound interest. However interest rates are now at an all time low. In 1989 Bank of England base rate was as high as 14.8%. Today it is a mere 0.1% with talk of negative rates being a real possibility.
A savings account is fine if you have short term needs for your money and can’t risk stock market volatility. If you want your money to grow, however, then you will be disappointed.
Beware the ‘silent killer’
There is a ‘silent killer’ that slowly eradicates the value of the cash in your bank account and it’s called inflation. Inflation is effectively the rise in the price of goods and services in daily or common use.
If you’ve ever watch the news on TV or read a newspaper, they often talk about the ‘Consumer Prices Index’, or CPI for short. Each month the Bank of England collects around 180,000 separate prices of around 700 items. These cover everything from a pint of milk to the cost of a football ticket. It is this very large basket of goods which is our measure of inflation, or the cost of living to you and I.
Inflation tends to rise over time and can be vastly different depending on your age. For example, a 25 year old will more likely spend more of their money on goods which go down in price over time, such as televisions, computers and cars. An 85 year old however will more than likely spend a good chunk of their income on services which increase in price, such as heating and care costs.
Here are two examples of how prices of everyday goods and services have increased over time. You can find more at https://www.bankofengland.co.uk/knowledgebank/how-have-prices-changed-over-time:
Interest rates and savings
Another issue with using a bank to save your money is the rate of interest. Put in the simplest of terms, you earn interest on your savings, which is a payment from your bank for allowing them to use your money.
The original idea of banking is fairly simple: you give your money to the bank, they use it to loan to others and charge them fees and interest for using it. In return, you are paid interest.
The problem is, interest has been at incredibly low rate for a historically long time. That means you are not getting a lot, if anything, in interest. When you consider all of these factors, you’re effectively losing money due to the combination of low interest rates and inflation.
And that will only get worse if the Bank of England decides to cut interest to negative rates. It may help those who borrow, but it is very tough on those who are saving.
Savings versus investing
Interest rates in 1990 where around 10%, so putting money in the bank would have been a great idea. Your money would have been safe whilst the effects of compound interest would have gone to work ensuring your nest egg built up quite nicely. In fact, £10,000 saved over 28 years at these rates would give you a tidy £162,500 with next to no risk, an increase of 1,625%!
However, times have changed and using a current rate of 0.1% you would, over the same time period of 28 years, accumulate a rather disappointing £283 in interest. Now I know in reality you can get more if you shop around, but at the time of writing this I haven’t seen a no-strings savings account offering more than 0.9%. Such an account would still only generate interest of £2,864 after 28 years, an increase of just over 128%. If you remember from earlier, the cost of milk has gone up 176% over the same period.
In contrast, a FTSE All-Share tracker would have generated an average return of 4.54% turning your £10,000 investment into around £35,500. I’m not advocating that you go and put your money into a FTSE All-Share tracker by the way, as you should take advice from a professional adviser or at least have a more diversified approach to your investments, but you get the point.
Longer term gains
And be warned that in that time you will have seen years where you had less money than the year before. But this is for longer term money remember, so short-term dips is all part of how you make the longer term gains. This has worked for over 100 years and it’s not new; it’s just much more accessible.
Investing does have its ups and downs, but careful financial planning can mean medium and long-term investing makes complete sense for most people.
And keeping to a plan is essential, which is why we try to educate our clients so it’s easier to hold them accountable to their goals and keep them focused. Anyone can get cold feet when they see their hard-earned money going down in value (2001, 2008 and March 2020 anyone?), but it’s those who hold steady and keep their nerve that come out on top.
Of course, there is so much more to financial planning than the basic numbers. But I hope this has shown you that when it comes to money, saving and investing are very different. So, if you are putting money away in a bank account because you think it is ‘safe’, think again.
To talk to us about your savings and investments, contact us today.