Many savers can often feel unsure or confused on how to make their money work harder for them. The lack of clear information on how to invest only compounds the issue, resulting in people leaving money in low interest savings account earning little to no interest. So why would you anyone choose to invest? What do you need to consider?
Before investing you need to assess your finances.
First and foremost, clear any expensive debts. Credit cards or other forms of fast credit will charge far more interest in a year than you could possibly hope to achieve in investment returns. Zero those first! Also think about your mortgage and overpaying for the same reason. There will probably be a limit on how much you can overpay and you wouldn’t want to get penalised.
Rainy day fund
Next consider a rainy day fund as invariably unforeseen events will occur, such as broken boiler or a roof damaged in a storm. This is where savings accounts come into their own as they will hand back a small bit of interest while still readily allowing you to get hold of your cash, and with very little risk (well, up to £85k – the limit of government protection). As a rule of thumb you need at least three months’ salary.
What are my financial goals
Now you’re at the stage to consider learning how to invest. In order to plan you need to think about what your financial goals are, which might include: saving for a house, having enough cash to give your kids in the future or planning for retirement. And you will need to think about how long you have to achieve your goals – time is of the essence! Anything less than 5 years and investments can be risky; 5 – 10 years, less so; 10+ years and the timeframe becomes ideal for investments.
The reason for this is that economies go through cycles of good and bad times, expansion and contraction, and markets tend to follow in lock-step. Within a 5 year period there’s a fair chance you could lose as well as gain, but in a 20 year time period markets tend to go up. It’s why most responsible fund managers tend to say to their clients: ‘invest for the long term’. That said, there are no guarantees to these time frames and, of course, investments can fall as well as rise.
A classic example of long-term investing is for retirement – allowing you to afford a gloriously sun-bathed apartment in the south of Spain or to live comfortably in your later years. It’s a pressing financial matter because people are living longer than ever before, adding on about 2 years life expectancy per decade according to the Office for National Statistics (ONS). Someone needs to fund our lengthy innings and the government say the onus is very much on us.
No time like the present?
History suggests that, from one perspective, now is as good a time as any to invest in stock markets because interest rates are so low. In 1979 they were 17%; at the end of 1989 they were around 14%. Today interest rates are 0.50% and unlikely to rise very quickly in the future. In other words – returns on cash savings are poor.
Now add to this the fact that inflation – the increase in the general cost of living – is around 3.1%. When you mash together inflation and the rate of interest you realise that not only are returns on your bank account savings paltry, rises in inflation are outstripping any gains, meaning the value of your cash is actually falling over time!
To give you an idea, take £100. If inflation was set at 2% a year, in 20 years’ time £100 would have the purchasing power of just £67.30. It may surprise you but this means the value of your money sitting in savings account is not actually increasing it’s decreasing over time. With that reality check ringing in your ears your next step is to choose what to invest in.
It’s important to remember that the rate of inflation will change in the future – just because the economy behaved in a certain way in the past, doesn’t mean it will do the same thing again in similar circumstances in the future. It’s also worth remembering that when you invest, you could lose money if your investments are worth less when you sell them.
Invest in what?
Once you have considered your financial goals and what level of risk you are willing to take how do you now choose what to invest in? This requires some research as there is a wide range of investment products available from a wide range of suppliers. To learn more about investment products see Step 1 for Investment Funds & Investment Trusts explainer or see Step 4 to learn more about the investment trusts we manage.