When you’re weighing up whether to save or invest, there’s always going to be a beady eye on how much money you could make. Using long term averages of medium returns, you might assume you could make 5% a year on a stocks and shares ISA. Meanwhile, a quick glance at the most competitive savings accounts on the market will see they pay 5% right now. So given that investing comes with added risk, it’s no wonder some people are wondering whether they should just stick with savings.
It’s a good question, but it doesn’t start and end with returns. There’s also the question of what the money is for.
If this is an emergency savings safety net, it needs to be in an easy access savings account, so you can get your hands on the money when you need it. If it’s for something specific over the next five years, it should also be in cash — although you can pick a fixed rate account and tie the money up for the period that suits you best.
Once you can tie the money up for five to 10 years or more, investments are well worth considering.
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In reality, most people will be saving and investing for different things at the same time, so the question then becomes whether investments are worth the bother for that slice of money you’re putting away for the long term — given that right now it looks like both saving and investing can return about 5%.
The main problem with this assumption is that you won’t necessarily get a 5% return on your savings.
Guessing the precise movements of interest rates isn’t a game anyone wants to get into — because the goalposts are constantly moving. However, it’s likely we’ll see savings rates fall in the coming months. So it makes sense to assume a long-term average return from a cash ISA is around 2%.
If you compare returns of 5% on investments versus 2% on cash, the difference can be impressive. It doesn’t sound much, but if you were to invest £20,000 for 20 years in a stocks and shares ISA at 5%, you could end up with growth of £34,253. If you left it in cash and got 2%, you could have made £9,827. It’s why stocks and shares ISAs should be part of the picture for significantly more than the 23% of people who say they invest at the moment.
And although 5% is a very sensible rule of thumb when working out the returns on investments, there may be circumstances where you could make more than 5%.
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Take the Legal & General International Index Trust — a fund which tracks a number of shares around the world. In the past 12 months, it has grown 19.7%. During the previous 12 months it grew 4.03%, in the 12 months before that it was up 6.55%, and the 12 months before that 24.92%.
The major consideration with investment is that you can’t ever know what kind of year you’re set for, and in some years the value of your investments will drop. This is why you need to invest for a minimum of five years, and not get carried away with expectations.
When it comes to the crunch, comparing long term averages of investments with the peak of savings rates doesn’t make much sense. The right answer for most people is usually a combination of the two.
• Sarah Coles is a personal finance analyst at Hargreaves Lansdown and co-presents Switch Your Money On podcast.
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