Many people are unsure when it comes to investing their own money. They prefer the safety of leaving their cash in a bank or building society. While it’s true you won’t see the value of your savings fluctuate in value on a daily basis, we are going to show why failing to invest can cost you money in the long term.
The type of assets in which you invest will be the greatest influence on your final returns, how risky your investment is and ultimately whether you achieve your objectives.
The four main types of asset:
- Cash (e.g. a savings account with a bank or building society)
- Bonds (e.g. a loan to the government or a large company)
- Property (e.g. residential or commercial property)
- Equities (e.g. shares in companies such as BP or Vodafone)
A general rule of thumb is that the riskier an asset is the greater return you’d expect to earn from it, over the long-term. We’re going to talking a lot about the long-term in this guide – and generally it means longer than five years.
Cash is generally considered to be the safest asset, but it also likely to give you the lowest return over a period of several years or more. Bonds are slightly more risky than cash but normally generate roughly the same level of long-term returns. Property tends to do well over long periods and the returns are quite stable. The returns from equities vary the most from year to year, but tend to be highest of all over long periods.
As an example of the difference in volatility, here in the UK, the real annual return of cash over the last 100 years (i.e. the annual return after taking off inflation) has been primarily between minus 5% and plus 8%. For equities, the majority of annual returns for the last 100 years fall between minus 15% and plus 25% and the chances of losing money in any individual year has been approximately one in four.
To illustrate what effect this can have, let’s look at some numbers. Here is the average annual return for cash, equities and gilts over the last fifty years (note that gilts are the main type of bond in the UK, being a loan to government). The figures are taken from the Equity Gilt Study produced by Barclays Capital.
Asset Average return
Equities 5.7% pa
Gilts 2.4% pa
Cash 2.0% pa
Expressed in percentage terms these figures don’t look that interesting. So let’s look at them another way. Say you invested £1,000 in each of these three assets fifty years ago. How much money would you have now?
Asset Value after 50 years
Investing in equities would have resulted in five or six times the amount you would have got from gilts or cash! And remember that these figures are after inflation, meaning the buying power of your initial £1,000 would have increased 16-fold over the course of the last fifty years.
No one knows what will happen in the next fifty years of course. However, these figures span numerous wars, recessions, shocks and other crises. We think they provide a reasonable guide as to what sort of returns to expect in the future as well. As we’ve seen in the last decade though, the returns from shares can be weak for a considerable period of time. A key point to recognise here is that if you want to earn a high rate of return, i.e. higher than you’d typically get from a savings account, you need to accept some risk. That means getting comfortable with the fact that your investments will go down in value some of the time.
The value of investments can go down in value as well as up, so you could get back less than you invest.
When To Invest?
That’s all very well, you might say, but I don’t have fifty years to invest. However, you might if you’ve just started work
and you’re looking to invest for your retirement. But investing in shares also works well over shorter periods, too.
Turning to figures from Barclays Capital again, we can see that shares have beaten cash the majority of the time over
shorter periods as well.
Period Shares have beaten cash
2 years 67% of the time
5 years 75% of the time
10 years 93% of the time
20 years 99% of the time
Even over a period as short as two years, the chances of shares beating cash are two in three. However, most people, us included, advise that you shouldn’t invest in shares for any period shorter than five years. The rationale is that the chances of losing money in less than five years, while fairly small, are still quite significant.
For example, there have been two occasions in the past 100 years where shares have fallen three years in succession. So you’re usually better off sticking to cash if you have definite plans for your money in the next five years (to put down a deposit on a house for example)
So when should you invest? The earlier the better. It’s advisable to keep a portion of your money in cash, in case of emergencies. Three to six months’ salary is a basic guide as this is often the period you’ll need cover before any insurance policies you may have start to pay out. This should be the minimum amount.
Once you have an emergency fund in place, the longer you give yourself to invest, the greater your returns are likely to be. So invest as soon as you can. There is a risk that you will invest just before stock market takes a tumble. There is very little you can do about this. No one knows how share prices will move over the next day, month or year. All we do know is that the long-term direction of the stock market has been up – but it’s not a straight line!
In practice, you’re unlikely to invest all your money at one particular point in time. It’s far more likely that you’ll invest small amounts of money on a regular basis. So whilst you might see immediate stock market falls some of the time, most of the time this is unlikely to be the case.
How To Invest?
Many people feel more comfortable getting a fund manager to do the investing for them. You can get funds that invest in particular markets such as the UK, US or the Far East. You can also get funds that invest in certain types of industries, such as banking, biotech or mining. You can get even funds that only invest in smaller companies.
We have created a number of bespoke investment portfolios that reflect a wide spectrum of clients’ risk profiles. Each portfolio typically holds many thousands of individual shares across a range of sectors and funds. We believe we have created cost-effective, diversified, risk rated portfolios to meet most clients’ investment requirements. Individual non-risk rated portfolios can be created where appropriate.
FPG Financial Services LLP is authorised and regulated by the Financial Conduct Authority FCA Firm Number 713421.
The Financial Planning Group is the trading name of FPG Financial Services LLP.