The financial services industry has so supremely failed consumers that any investment firm communicating why someone should invest sounds like a barber advising someone that they need a haircut. Most people understand and know that investing something today has the potential to grow in value into something more in the future. However, the comfort of seeing our current tangible bank balance seems far more real than some hypothetical potential increased value in the future. Markets can be incredibly risky so investing, and potentially losing, your hard-earned money into something you might not feel you understand rightly seems anathema to most people.
We help new customers understand the basics of investing with our posts, interviews and video academy. But experience requires practice and practice takes time. Why should you invest a few minutes setting up bespoke portfolios for your goals in a simulation account? In fact, why you should even invest at all?.
The biggest risk is not taking any risk.
If investing has the potential to lose your hard-earned money why would anyone risk this? Keeping your money in cash surely has very little risk attached to it. In fact, a bird in the hand is after all better than two in the bush! The truth of the matter is when it comes to taking a long term view, like all investments should ideally be, not investing is almost guaranteeing that you will be far worse off.
Let’s say you accumulate £10,000 in savings and you plan to leave this in your trusty bank account. What do you think the value of that money will be worth 10, 15 and 20 years from now?
The average rate of inflation in the UK from 1900 until today has been 4.33%. If we just half that for prudence sake and apply that to your “safe” money in the bank this means your hard-earned cash will be worth 2% less every year. This might not seem like much, the markets can and do go down far more, however over time through the power of compound interest, the value of your savings is slowly whittling away.
The £10,000 will go down, in real terms, to £8,170 in 10 years, £7,386 in 15 years and £6,676 in 20 years and £5,454 in 30 years. You are guaranteed to lose 18%, 26%, 33% 48% of your money by doing nothing.
If your cash is losing 2% per year what about the large losses you have heard about in the markets? Well it is absolutely true, over the short and medium term markets and asset classes can and do lose a lot of value. The chart below indicates the maximum and minimum real returns of US stocks and bonds over a 1, 2, 5, 10, 20 and 30 year period from 1802 to December 2006. What it shows is the most returns US stocks and US bonds have given over a holding period, but also the largest losses suffered in those asset classes over the same period.
Over a 1 year period therefore US stocks have in the past lost (in real terms) 38%. As one can see from the chart the maximum amount lost in stocks and bonds naturally decreases over time and actually becomes positive for equities. Over a 30 year time horizon the best annualised return of stocks was 10.6% and the worse 2.6% whilst for bonds the best annualized return was 7.4% and the worse -2%. Therefore investing for long periods of time naturally decreases the chances of losing money. This is due to the power of compound interest and the fact that markets tend to naturally grow over the long term (as economies get bigger and companies grow).
Does this mean that you are guaranteed an outcome? Absolutely not, as we have pointed out equities can lose up to 38% in one year. However, if you invest for the long term, the risk of your portfolio and investment naturally decreases and the potential for upside increases. This compares rather favourably to the alternative of staying in cash which guarantees a loss of value over similar periods.
If we have made the case that investing is actually less risky than cash over the long term the next important step is to consider what you want to invest for. Your long term investment goals. Most people go through a lifecycle when investing where they start their careers and start planning, savings and investing towards retirement, a house and/or a family. Determining what your long term investment goals are is therefore incredibly important. Hopefully this blog has made you realise the importance of formulating your investment goals and the need to invest towards them over the long term in order to achieve the best outcomes.
Whether you are starting your career, a family or planning for retirement, starting early and investing consistently goes a long way to helping you achieve those goals.
As we are client-obsessed at ETFmatic we are constantly working to help clients achieve these long term investment goals. That is why we are committed to having some of the lowest investment fees available in the industry along with zero management fees for children under the age of 18.
We are therefore delighted to announce our new life cycle investing campaign. Over the next 3 months we will help our new and existing clients think about these long term goals. So check back in next Friday May 19th where we will be announcing something exciting.