It can be very tempting to keep money in the building society or in a deposit account as you cannot lose money, right?
The simple answer is yes, but the long answer is most certainly NO. Let me explain.
Let’s say you have worked hard all of your life and you have managed to accumulate a nice tidy sum of money, say £150,000. You don’t have it earmarked for anything in particular, you just like having the money around and it allows you to sleep well at night, knowing that if anything comes along that you had not anticipated, you will have the money to sort it out, whatever it may be.
I can sleep at night because it’s safe. Let’s look at this in more detail. Most deposit accounts are currently paying historically low rates of return and you are most likely earning between 1.0% and 1.5% a year if you are lucky or at least something like that. And I‘ve got a pretty good idea why you are doing it. You are either afraid of losing money or most likely you have previously lost money on your investments.
Back in 2008 the markets took a tumble and if you lost your nerve, you may well have sold your investments at a loss and made a promise to yourself that you would never let that happen again. Sound familiar? In other words you wanted your money to be safe.
Now you are not alone if you are thinking like this as millions of people have made exactly the same decision as you and for all the same reasons.
The tax man takes his cut. So let’s say you are earning 1.5% a year on your deposit money. If you are a basic rate tax payer this will net down to 1.2% a year and if you are a higher rate tax payer 0.9% a year. Not very attractive, I hear you say, but it’s still safe. If you are holding the money in a Cash ISA, there will be no tax on the interest you earn.
Have you thought about the effect of inflation? Inflation is currently running at a very low level, but we are not looking at the short term. Long term inflation far outstrips the current interest rates returns. Between the year 1990 and 2014 we have had inflation of 117.19%, which is 3.28% a year (estimates from the Office For National Statistics). In simple terms if you invested £1,000 24 years ago earning 1.5% a year and inflation was 3.28% a year, the real value of the original investment would now be £671.
So in real, after taxes and after inflation, your money is actually falling in value. The difference is, you are just losing money safely…….
Would I be right in thinking that you are fearful of investing in the markets? So if you are to start to think needing a better investment return, a different mindset is needed perhaps. At the moment we know cash is guaranteed to lose money in real terms, so maybe your current mindset is more like “a dislike of uncertainty” as opposed to a dislike of loss.
So how can reduce uncertainty? There is no absolute way to avoid uncertainly, however a diversified strategy investing in a wide range of different assets across a range of different sectors, is more likely to reduce the uncertainty in your investments. Let me give you an example.
A range of diversified assets, would include an element of cash, yes cash, fixed interest investments, property backed investments and equity type investments (stocks & Shares).
And sectors could be geographical. For example a portfolio may have a proportion invested in the UK, perhaps some in America, some in Europe and other developed economies. There are no certainties my moving away from investment in cash, the returns you get are going to be unknown for sure. However, if we keep all our money in the bank we are guaranteed to lose real value in our money.
How do I control my emotions? This is tricky for many investors. Remembering the reasons why you made the investment in the first place is very important. For most of us, investing is looking at the longer term picture; however we can easily be derailed if the markets wobble or we get an unfavourable valuation. Also, if you do not need the money in the near term, does an intermediate value matter all that much? When markets take a tumble, there is usually a recovery and in many cases a recovery is often soon after a fall. Markets often overshoot when they fall, so a rebound often happens.
How much should I invest? The quick answer is definitely not all of it. We all need an amount of cash around us that we can access for unforeseen circumstances. If you are new to investing, or a coming back to investing after a break, a small proportion of you savings to start with. Perhaps just 10% to 15% of your savings until you become more comfortable.
It’s shouldn’t be all or nothing. Investing should never be just one strategy; none of them are immune to problems. My mother always said “never put all your eggs in one basket”. There is just too much risk in this strategy.
So I would encourage you to meet with a financial adviser who can help you decide whether a little bit of risk in your strategy is right for you.
This article does not provide specific advice and you should always seek professional advice from a qualified adviser before making any decisions.
Contact Martin Dodd on 01902 742221 or email him at [email protected] if you would like talk about money issues.
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