Why invest? Get the basics right

Investing

MoneyPlus Features Team

5th July 2019 at 10:51am

If you want to invest to give yourself the best chance of success, it’s a good idea to get the basics right. So let’s take a look at why you might want to invest in the first place.

There are three big reasons to invest

1. Give your money the chance to grow through investing

When you invest your money, you’re giving it a chance to grow in value. It will almost certainly go down as well as up in value, especially in the short term. But, generally, the longer you leave your money invested, the better your chances are of seeing it grow and giving you better returns than if you put it in a savings account. However, your money is generally secure in a bank or building society.

Taking a long-term view can also mean you don’t need to worry so much about short-term market falls, which, of course, do happen.

Let’s take a look at an example of investing against saving over the long term:

The Investment Association is the trade body that represents UK investment managers. If you look at the 1,722 funds listed by the Investment Association in the UK that have a 10-year performance history, you’ll see that more than 99% gave a better return than cash savings over that period. And the average return was 9.8% a year compared to just a 0.7% return from the average savings account. These funds represent some of the most popular funds in the UK.

It’s worth noting that we’ve now had a 10-year bull run coupled with interest rates at historic lows for the whole period. So it’s also worth looking at the previous 10 years (which included the dotcom bubble and the global financial crisis). Over this period, the average fund return was 3.34% compared to a 5.15% return from the average cash account.

A bull run is a period of time when prices rise on a financial market.

Source: Morningstar Investment Association Universe, cumulative returns, net income reinvested, 30 April 2019. Past performance is not a guide to future returns.

Not convinced? Just think about your morning latte

Starbucks entered the UK market after it bought the Seattle Coffee Company in April 1998. Since then, if, instead of spending £2.50 a day on your morning latte, you’d invested £50 a month in the US stock market, you’d now have amassed £23,000.

If market ups and downs are still a concern for you, many investment companies nowadays offer funds designed to manage volatility – how much investments move up and down. So you can actually choose investments that aim to give more consistent returns, and shouldn’t experience the extreme highs and lows that markets can.  If you don’t want to pick your own investments, there are plenty of ready-made diversified options for ISAs and pensions that aim to give you the highest possible return for a given level of risk.

Remember though, the more risk you take with your investments, the more downs as well as ups you’ll see, but the better returns you’re likely to get over the long term.

You can even get ‘free’ growth on your investment growth

Yes, it’s really possible – it’s called compound growth – something Albert Einstein is said to have dubbed the eighth wonder of the world. It might sound dull but the effect on your money is quite exciting as it’s one of the things that can really help you get a better return than saving in a cash account.

Let’s say you invest £100. Any growth you get will be added to that £100. And the next year, any further growth you get is added to your original £100, plus all the previous growth. If you leave your investments to grow, this happens year on year – it’s the ‘snowball’ effect. The growth may be small over one year, but over time compounding can potentially build up the value of your investments significantly.

So if your goal is to invest to achieve a large final amount, such as £100,000 over a period of time, the compound growth on your investments can contribute towards this – meaning you may not actually have to pay in as much yourself. Of course, there are no guarantees and investments can fall as well as rise in value, and you could get back less than was invested.

Remember then, investing early and taking advantage of compound growth could be one of the biggest favours you ever do for yourself.

2. Generate an income through investing

Another reason to invest is to generate an income. When you’re saving for your retirement, the chances are you’re investing mainly for growth as you’ll want to try to build up as large a pot as possible. But nowadays many people are keeping their pension savings invested once they’ve retired, and taking money out as an income – you might see this called taking a flexible income or drawdown.

This is a balancing act though as you’ll need enough to cover your immediate spending, but you’ll also need your money to last you through the rest of your life. That’s why it’s important to consider an investment plan that can deal with these challenges. One way to do this is to have a carefully managed mix of lower risk investments for the income you plan on taking in the shorter term and potential growth investments for your longer term needs.

You can also generate what’s known as a ‘natural’ income through investing. Many of the most popular types of investment are ‘income-generating’. For example, companies will often give out a proportion of earnings (dividends) each year to shareholders, bonds make regular interest payments (coupons), and property receives rental income.

You can choose to take this income or you can choose to reinvest it if you’re investing to potentially grow the value of your money. If you go down the route of taking the income, it’s important to bear in mind that your investments might not rise in value as much as if you reinvest it. This is because reinvested income not only adds to the value of your money but also benefits from the compound growth we mentioned earlier.

You can find out more about different types of investments, including how they can generate income for you, in our guides on where to invest.

3. Help protect your money against inflation by investing

The third big reason to invest is to help protect your money from the effects of inflation. If you need to access your money in the short term (five years or less) then leaving your money in a savings account can make sense. But leave it any longer and it’s likely to lose value when you take inflation into account.

The effect of inflation means that cash savings could effectively lose you money every year. The chart below, based on £10,000 invested, shows the effect of inflation on a typical savings account over time. Since 2008, interest rates have been very low and, importantly, less than inflation. So your cash savings would be steadily worth less and less in today’s terms.

Cumulative returns before and after inflation to end May 2019. Gross income reinvested.

Representative bank rate based on Bank of England (BOE) rates sourced from Bank of England.

Representative bank rate doesn’t include charges.

‘Adjusted for inflation’ means inflation based on Consumer Price Index has been taken into account.

Source for inflation: Morningstar.

That’s why you might want to consider investing if you want to give your money the chance to maintain its value and, more importantly, the potential to grow in value.

What’s next?

Now you know why it could make sense for you to invest, the next step is to find out how. If you’re still unsure about investing you can get professional advice from 1825 – Standard Life’s financial planning arm* or visit unbiased to find an adviser in your area.

This article should not be regarded as financial advice. The information here is based on our understanding in June 2019. Your personal circumstances also have an impact on tax treatment.

The value of investments can go down as well as up and may be worth less than you paid in. Past performance is not a guide to future returns. If you’re looking for help with any of these things it could be worth speaking to a financial adviser. There is likely to be a charge for this.

 

*1825 is a trading name of the advice entities of Standard Life Aberdeen Group.