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Is it better to have cash savings or should you look to invest your money? Whilst cash savings won’t fall in value, they will be impacted by inflation. On the other hand, investments could provide an effective option for your money over the longer term, but there are risks involved.
In this article, Jonathan McDowall from Henderson Loggie Financial Planning provides an overview of cash savings vs investments to highlight the differences between the two options.
Why would I use cash savings?
By cash savings, we mean a bank or building society savings account. These come in different forms, ranging from instant access savings accounts, notice accounts, fixed-term deposits and cash ISAs. The return that you receive on cash deposits will be determined by the interest rate that the bank or building society provides. In turn, the interest rate that they provide is influenced by the Bank of England base rate.
Cash savings are regarded as safe, and the value of your money will not fall. There is also protection offered by the government under the Financial Services Compensation Scheme, so if a bank or building society were to become insolvent your money would be protected by up to £85,000.
Generally, cash savings are better suited for shorter-term needs, so money that you know you may require in the short-term or money used for an emergency fund.
Are cash savings risk-free?
Whilst savings in a bank or building society won’t fall in value, they will be impacted by inflation. Interest rates have been very low since 2009, so over that period you will have received a very modest return from cash savings. The main risk is inflation eroding the purchasing power of your money, in other words, your money will buy less for you in the future.
Why would I consider using investments?
Investments come in various forms and differing levels of risk. This could range from holding individual shares where you own a small part of an individual company, to managed investment funds that can invest across a range of assets and are managed by an expert for you.
When investing, the returns that you receive are based on the performance of the assets held, for example, shares, property and bonds. These offer the potential for greater returns than interest rates can provide and also the potential for your capital to grow or an income to be received that can outstrip inflation, providing a real return over the long-term.
Investments are generally best held for longer-term periods of at least five years. Therefore they’re better suited to meet longer-term financial objectives.
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What are the risks of investing?
All investments carry some form of risk and this varies depending on the type of investment held. The value of an investment can fall as well as rise, and you may get back less, depending on when the investment is sold and the market conditions at that point in time. The returns received are also variable and they’re not guaranteed.
What does saving vs investing look like over a longer period?
Because of the potential risks of investments, they are better to be held over a long-term period. By taking this approach this offers the opportunity to benefit from the higher returns that can be provided by investments, but also gives you time to recover from any falls in value that may occur along the way.
In this graph, we highlight the performance of an average investment that is invested across a range of assets including shares, property, bonds and cash. This is set against the Bank of England base rate and it’s also set against the Consumer Price Index, as a measure of inflation.
This graph shows both negative and positive periods throughout the timeline. In particular, it highlights the financial crisis of 2007/2008 showing a significant market event and the impact it had on the investment value, but also the recovery that was experienced after that.
What does this comparison show us?
This highlights how an investment can perform versus cash savings and inflation over a longer-term period, even with a significant market event. It also highlights the potentially greater returns that can be received from an investment over the longer-term, even with fluctuations along the way.
So, for an individual that has surplus capital that isn’t required over a longer-term period and they wish to achieve greater returns, an investment can potentially provide a good solution for this. However, it is important to point out that past performance is not necessarily a reliable indicator of future performance.
In conclusion
We believe in diversifying and having an element of your portfolio in cash as well as an allocation to longer-term investments, where appropriate. Firstly, it’s important to have the security of an emergency fund in place and then have money set aside for use and enjoyment. Then you should think about the future and money that you wish to work harder and earn a better return, could be allocated to investments.
Hopefully, this article has provided a useful comparison of cash savings versus investments. If this is something you’d like to discuss in more detail please get in touch using the form below.