Investing your hard-earned money can feel overwhelming. Many choose to keep their money in the bank.
With many tempting savings accounts and attractive interest rates available, some may wonder why investing matters. However, we want to explain why investing, especially in a diverse global portfolio of equities and fixed interest, is still a powerful strategy for generating wealth, even when cash returns seem promising.
Why shouldn’t I keep my money in cash over the long term?
To begin, let’s consider the downsides of holding onto cash. While it may feel safe, it has a significant drawback: it doesn’t increase in value over time. There’s no denying the appeal of a high-interest savings account. While cash might offer attractive returns during periods of high-interest rates, it’s essential to understand that these rates fluctuate and do not remain high forever. Due to inflation, the buying power of your cash slowly diminishes [1]. For instance, if inflation is 2% annually, the £1,000 you have now would be worth roughly £820 in 10 years.
What would I invest in as an alternative to holding cash?
Investing your money can help it grow over time and potentially outpace inflation. Our proposed investment strategy consists of two primary components: equities and fixed-interest investments.
When you own equities, you own a part of a company and can earn a portion of its earnings and assets. Over time, equities have historically offered higher returns than other types of investments [2]. However, their value can also be volatile, so it’s wise to diversify your investments to minimise potential losses.
Fixed Interest Investments, also known as bonds, involve lending money to a government or corporation in exchange for regular interest payments and repayment of the loan at a set time. Bonds generally offer lower returns than equities, but they are also typically less risky and provide a reliable source of income [3].
What do you mean by diversification?
In finance, you’ll often hear the term “diversification”. This refers to spreading your investments across different types of assets and geographical regions. The aim is to reduce risk; as the saying goes, “Don’t put all your eggs in one basket”.
By investing globally, you can diversify your portfolio even further. This approach allows you to take advantage of growth opportunities in various economies, which can cushion the impact if one region experiences a downturn.[4]
For instance, when the UK economy struggles, other economies in Asia or the Americas might be performing well. A globally diverse portfolio would enable you to benefit from this performance and reduce the overall risk of your investments [5].
To achieve a balanced portfolio and optimise returns, it’s essential to have a combination of equities and bonds. For investors who are younger or willing to take on more risk, a more significant percentage of equities may be a better option since they have the potential for higher returns over the long term. On the other hand, individuals with a lower risk tolerance may prefer to have more bonds in their portfolio since they offer a stable source of income and lower risk [6].
Should I keep my money in cash when the markets are down and wait until they recover?
One investment strategy involves moving funds to high-interest accounts when the market is down and returning to the market when it improves. This is known as “timing the market” and may seem straightforward, but even professional investors find it difficult to predict market movements. Market recoveries can happen quickly and unexpectedly, making it challenging to wait for clear signals of improvement and potentially miss out on substantial growth.[7].
While switching between high-interest accounts and the market during downturns and upswings may seem attractive, it carries significant risks and potential missed opportunities. A balanced, globally diverse portfolio of equities and bonds can provide a more steady, reliable path for long-term financial growth.
During difficult financial times, a good advisor can offer guidance and provide a sense of calm to help you stay focused on your long-term financial goals. By explaining the realities of market cycles, they can encourage patience during downturns and caution during booms, preventing impulsive decisions.
A good advisor not only helps you put together and maintain a financial plan, but they help you stick to it also. If you have any questions, you can book a free, no-obligation chat here.
[1] Blanchard, O. (2021). Macroeconomics. Pearson.
[2] Dimson, E., Marsh, P., & Staunton, M. (2020). Credit Suisse Global Investment Returns Yearbook 2020. Credit Suisse Research Institute.
[3] Ilmanen, A. (2011). Expected Returns: An Investor’s Guide to Harvesting Market Rewards. Wiley.
[4] Markowitz, H. (1952). Portfolio Selection. The Journal of Finance, 7(1), 77-91.
[5] Solnik, B. (1974). Why Not Diversify Internationally Rather Than Domestically? Financial Analysts Journal, 30(4), 48-54.
[6] Bernstein, W. J. (2001). The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk. McGraw-Hill Education.
[7] Barber, B. M., & Odean, T. (2000). Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. The Journal of Finance, 55(2), 773-806.
