What are you investing for?
Don’t worry. This isn’t some deep philosophical question; it means just what it says – what are you saving your money for?
Because there’s one very simple thing you have to decide: if you want the money back within five years, then you need to save it – that means in a nice, safe, but boring deposit account. If you don’t need the money for at least five years, then you can invest it – in the stock market, for example.
Why the difference?
Because when you invest in the stock market (or any other market), there’s no guarantee you’ll get your money back. Especially in the short term. It’s risky, and you could easily lose money rather than make more of it.
And if you pick the wrong time to invest, you could be waiting for much longer than five years to get your money back.
I’ve been digging through the latest edition of the annual Barclays Equity Gilts Study. This report shows how various ‘asset classes’ – cash, shares and bonds – have performed over the past century or so.
Some of the data is eye-opening.
If you’d invested in the UK stock market at the end of 1973, you’d have lost more than half of your money by the end of 1974. That’s right – more than half your money gone in a year! If you invested at the end of 1972, it would have taken 11 years before you were back to even.
More recently, anyone who invested at the end of 1999, near the height of the technology bubble, is still waiting to make a return on their money. (These figures assume that any dividend income is re-invested).
That’s pretty scary. You might not want to take that kind of risk.
In the short term, that’s a very sensible attitude. That’s why you put money you are saving for a deposit on a house into a savings account, not the stock market.
Trouble is, you can’t avoid risk completely. Fluctuating stock markets are one problem, but when it comes to long-term savings, there’s another big risk that can gobble up your hard-earned cash.
I’m talking about inflation.
Staying out of the stockmarkets won’t protect you from inflation…
The cost of living tends to rise over time. So if you have £1,000 today, in a year’s time it’s going to be worth less than £1,000. You just won’t be able to buy so much with the same amount of money.
Let’s say prices are rising at 5% a year. 5% of £1,000 is £50. So in a year’s time, you’ll need £1,050 to buy the same amount of stuff that £1,000 will get you now. £1,050 is a bigger number than £1,000. In financial jargon, the ‘nominal’ amount is larger. But ‘in real terms’ (taking inflation into account) you are no wealthier at all.
You need to beat inflation – which means taking risks
The problem we have is that if we want to have a hope of retiring in comfort, then it’s not enough just to keep up with inflation. We have to beat it soundly. And looking at financial history over 20-year periods since 1960, one of the best ways to do that is by investing in shares.
Let’s look at some more figures from the Barclays Equity Gilt Study.
Assuming you re-invest dividends, there isn’t a single 20-year period since 1960 where you would have made a ‘real’ loss in UK shares.
You can’t say that for deposit accounts (cash), or for gilts (UK government debt). Even in the worst 20-year period for stocks, £100 invested in shares was worth £143. For gilts, the figure is £62, and for cash, it’s £96.
As for the best 20-year periods for each asset class: £100 invested in UK shares grew into £1,224. (From 1974 – 1994).
£100 in gilts grew to £487 (1981 – 2001). And over the same period for cash, you’d have ended up with £195.
Of course we’re not comparing like-with-like time periods here. There are good and bad times to buy various asset classes. Plus there are other important types of investments. The Barclays study doesn’t look at property or gold, for example.
However, the fact remains: if you are investing for the long run – for retirement in other words – then the markets, not a savings account, are the place to put your money.