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As an investment director here at Investec Sheffield, naturally, I believe in the power of investing to help you achieve your financial goals. Regularly I speak to clients who prefer not to invest in the stock markets, and often it is because of the risk involved. Whilst it is true that investment does involve risk, here’s how it can be of benefit to you as part of a long-term strategy.
The trouble with cash: interest vs. inflation
In recent years, cash savers have had to contend with the record low interest rates on their savings. Since the financial crisis, the Bank of England has cut its interest rate significantly, which has meant that the rates available for either in cash ISAs or fixed-term savings accounts have similarly dropped.
Against this backdrop, inflation has averaged about 2% per year over the last decade. As a result, holding significant cash deposits has actually meant a decline in the real worth of their purchasing power. This situation was exacerbated for many savers in late 2020 when National Savings & Investments (NS&I) cut the rates available on their popular income bond savings products.
Holding cash remains an integral part of any long-term savings strategy. Cash does not fluctuate in value when the price of other assets may be falling, so it is important to maintain a healthy ‘rainy day’ cash fund for unforeseen expenditure. However, for longer-term saving, it is often advantageous to take a managed level of risk in the hope of getting a better return than is currently available from cash.
Embracing risk for greater potential returns
According to data compiled by MSCI and Bank of America, over the last decade, investors in the UK equities (stock) market have enjoyed an average annual return of 5.1%. For investors in overseas equity markets, the rewards have been even greater, averaging returns of 11% per year. It should be noted that such returns come with a higher degree of uncertainty, with UK equity markets having an average annual volatility of 12.6% over the last decade and overseas equity markets an average volatility of 11.5%.
Investors need not solely look to stock markets in the hope of generating a better return on their savings. UK government bonds (otherwise known as gilts or fixed-interest assets) have returned, on average, 4.7% a year over the last decade, with approximately half of the volatility exhibited by stock markets. The returns from corporate bonds - that is, debt issued by corporations rather than sovereign governments - have averaged 7% with an annualised volatility of 6.2%.
Such returns are attractive for those who can bear the increased risk associated with investment in stock markets and bond markets.
Managing risk at a level you’re comfortable with
Investing in a portfolio which incorporates a range of different investments, including more volatile investments (such as equities) and less volatile assets (such as bonds and cash) will help to diversify risk and reduce the extreme ups and downs of investing in a single asset class.
It is important to carefully consider your own appetite for risk and your ability to bear any losses that may be incurred. However, over the last decade, it has certainly paid to take on some risk as a long-term strategy for getting better returns on your savings.