Q – What is a guaranteed way to lose money?
A – Put your money in cash in a deposit account with a bank or building society!
So how can this be, after all we have always been told that investing your money into the stock market is risky and keeping your cash on deposit is safe. Well this is a true to a point but the problem is that cash held on deposit is most unlikely to keep pace with inflation. Whilst you will still have your capital and some interest, it is very unlikely to be worth as much in the future.
Let me explain my thinking; assume you have £100 today and this buys you a supermarket trolley load of food. In five years you would still have your £100 which will have attracted some interest but the price of the same trolley load of shopping is likely to have increased by more than your £100 would have grown by. Therefore, in five years it is most unlikely your £100 sum plus interest will be enough to buy the same trolley load of shopping.
In the good old days when interest rates were around 5-7%, you could put your money on deposit and to a certain extent, live off the interest. Many people in retirement did just this, relying on the interest from their savings to supplement pension income. However, these days it is a very different story - the super low interest rates that we are currently earning with cash on deposit are simply not keeping up with the rise in prices of the goods we buy; just think of how much our utility bills, food & petrol have risen in the last few years.
So what is the answer? Put all you money in the stock market? Whilst this might work over the longer term, it is certainly a very risky strategy and you could end up being forced to liquidate your investments at a time when markets have taken a sharp decline, resulting in you selling at a loss. I believe that we all need basically two pots of money – a cash pot and an investment pot.
The cash pot is for your immediate and short-term needs i.e. replacing a car, a holiday, decorating the house etc. This pot will not earn much but it will be safe and you can access capital instantly without fear of realising a capital loss. The investment pot is your longer term savings where you can put your money away for say five years or more. In a managed fund your money will be invested across a range of assets with some of the capital exposed to the stock market. The capital value will fluctuate with the ups and downs of investment markets and at times could be less than the amount that you originally invested, however, over time the investment pot should keep pace with inflation and provide you with a good return.
So how much do you need to keep in each pot? Well that all depends on your requirements and objectives and to help reach a decision on this you need to ask yourself the following questions:-
- What are my spending plans for the next three to five years?
- How long can I invest for? This will often depend on your age; a 30 year old may consider a long time frame whereas a 75 year old may consider a shorter period of time.
- What is your attitude to risk? By how much could your investment pot fall in value before you would start to feel uncomfortable?
There are some people who think investing money in anything other than in deposit accounts is just too risky. I tend to find that people who hold a sum of money in their cash pot (which makes them feel comfortable) worry much less about the ups and downs of investment markets. In the short term enjoying the security of deposits is reassuring whilst in the long term the insidious effects of inflation are by far, I believe the biggest threat to our wealth.
As with most things in life taking professional advice is key and a discussion with an Independent Financial Planner can help you choose the right course to take.