Every now and again, a new client will tell us they are extremely cautious and do not wish to take any risks with their money. Similarly, individuals who have already invested become nervous about the outlook for investment markets and express a desire to move into cash. What these individuals fear is losing money. While this is completely understandable from an emotional perspective – and, fundamentally, in my mind the best investment is always the one that helps you sleep at night – I’m afraid the logic behind this fear isn’t.
Most people believe a cash deposit is the safest way to secure their money. In one way, this is true; although the interest you earn on your deposits may change from time to time, the underlying capital will always remain the same. However, the banking crisis we encountered 10 years ago should act as a reminder that not even cash is 100% secure. If the bank or building society with whom you have deposited your money fails, then you stand to lose your capital (although the first £85,000 should be covered by the Financial Services Compensation Scheme).
Although a bank is a useful home for any money you may need to access in the short term, a major issue with cash is that the interest you earn is unlikely to maintain the value of your money against inflation. A deposit of £10,000 earning interest of 1% per annum would grow to £11,046 over 10 years, for example, but annual inflation of 3% over the same period means that capital sum would only be able to buy goods to the value of £8,219 in today’s terms. Put another way, a car valued at £10,000 today would cost you £13,439 in 10 years’ time. At that point, the car would no longer be affordable, as your capital would have only grown to £11,046. This means you would have to find the money elsewhere to make up the difference – or buy a cheaper car.
Is cash king?
Although the value of your capital is unlikely to fall when held on deposit – making it an ideal solution for money you may need in the short term or in the event of an emergency – the major risk with cash is that it is unlikely to offer an adequate return over the long term and, in time, this may well lead to an inferior lifestyle.
This dilemma can be countered by investing in other assets that have historically produced superior long-term returns over and above cash and, for that matter, inflation. In the short term, however, these investments tend to fluctuate in value, both upwards and downwards.
But herein lies an important lesson – any fluctuation in value is temporary. You only make a profit or a loss when you sell the investment. If you have no need to sell, you are unable to suffer a permanent loss of capital. And it is a permanent loss of capital you should be afraid of, not a short-term fall in value.
To invest in assets other than cash, you have to have faith that the underlying markets will continually yield returns over the long term, although you may encounter the odd setback here and there. If you do not hold that faith, then there is no point in investing. Unless you have a need to raise capital, there is no reason, therefore, why you should encash any long-term investment, just because values have fallen.
Weather the storm
Trying to optimise your return by taking your money out before a fall in market values and then reinvesting when prices are set to recover is an idealistic tactic, but in reality is almost impossible to achieve. For most investors, retaining faith in the markets, displaying discipline in ‘weathering the storm’ and being patient are far better attributes.
Indeed, in the majority of circumstances, the way you behave around your money has a greater impact on your wellbeing than the investment strategy you decide to adopt. If you are saving for a particular goal, for example, saving the correct amount of money is far more important than where you invest the money. Focusing on the potential outcome of any given strategy, therefore, rather than the attributes of a particular investment is a key factor in ensuring satisfactory results. Running out of money in retirement is a major issue.
Allowing inflation to erode the ‘purchasing power’ of your savings will, over time, lead to an inevitable drop in your standard of living. Not having sufficient life assurance may cause your family financial hardship in the unfortunate event of your death. These are things to be concerned about. A temporary decline in the value of an investment you have no intention of accessing for many a year is not something to fear.
Indeed, with the long term in mind, this is an investment trait you should learn to embrace. We focus on volatility, the degree to which an investment may fluctuate in value, in terms of ‘losing’ money, but it is volatility that drives the markets. Without volatility, investments would not produce superior returns compared to cash.
Admittedly, you may not wish to expose money you plan to access in the short term or in the event of an emergency to the vagaries of investment markets, but not investing your capital presents a risk, in itself, over the long term. In order to seek better outcomes and enhanced financial wellbeing, therefore, it is important you overcome any fears you may have about your money. In order to do that, it helps if you can get a clear perspective on what you are trying to achieve and a comprehensive understanding of what exactly is at stake. A good financial planner can assist you in this regard.