Saving versus Investing
When putting money aside for the future, some people just stick it into a savings account because they don’t want to lose any money. This makes sense but as I explain the right decision is a bit more complicated, particularly if you are putting money away for a long time such as with child savings or a pension.By
When we were carrying out research for Beanstalk, I met a mum with an 18 month old son. She was putting £50 a month into her son’s cash junior ISA with the goal of giving him a nice lump sum for when he turned 18. Great – starting early is never a bad thing as it gives longer for your money to grow.
She was an accountant by profession and she explained that she was putting the money into a cash JISA (which pays interest) as it was safe and she did not want to risk losing money. Again I understood why: cash JISAs are offered by banks and building societies and the savings are protected under a deposit guarantee system (up to £85,000 per person per bank).
I then asked her where she put her pension savings and it turned out it was invested in stocks and shares because she felt that, as it was for the longer term, the risk of losing money was compensated by the potential returns. The light bulb then went off as she realised that she was putting money aside for her son for 18 years and her pension for not much longer.
Interest rates and inflation
Typically savings account offer fixed interest rates (which they vary from time to time). For example, if the bank offers 1% annual interest, then after one year £100 in a JISA would be worth £101. Banks normally set their interest rates considering the “base rate” which is set by the Bank of England and make money by paying savers less interest on their cash than they charge to people who borrow from the bank.
Although cash JISAs give certainty (you know that the savings will grow by the interest rate), one thing to think about is the effect of the inflation rate on the value of your child’s savings. If inflation (the general increase in cost each year of goods and services) is higher than the interest rate, then despite the fact your savings have grown, they will be able to buy less with the money than they could at the start.
Interest rates vary by bank and by product but Bank of England data showed that during 2019 average interest rates earned by individuals on time deposits was between 0.9% and 1.0%, somewhat less than the monthly rate of inflation (CPI) which varied between 1.3% and 2.1%.
Why consider investing?
Unlike saving where your returns are dependent on the interest rate, returns from investing depend on how well the investments do. There is of course a risk that you could end up with less than you put in but evidence suggests that, over the long term, stocks and shares tend to outperform cash as the returns can compensate for the ups and downs.
For example, the Barclays Equity Gilt Study in 2019 showed that over 50 years, UK shares would have returned 4.7% whereas cash would have returned 1.1%. In some years cash would have significantly outperformed equities but over the longer term it was the other way around.
The study also showed that since 1899, money invested in UK shares and held for 10 years would have outperformed cash savings in 100 out of the 110 years, which is one of the reasons why many people choose to put their pensions and other longer terms savings into investments rather than cash.
Of course only you can decide what level of risk and return you feel comfortable with and what is right for you but hopefully I have given you a few pointers as to some of the things to think about.