Some people say investing is complicated. We don’t think it has to be. First, start with your goals. After all, we all have dreams and aspirations and we want to be able to pay for these one day.
Some goals are easier to define than others. Perhaps you want to own your home and need to build up enough of a deposit to get a mortgage. Or maybe you want enough money to be able to retire at the age of X with an income of Y.
Growing your wealth
Other personal goals are vaguer. After all, whose life is perfectly mapped out?
We may have an idea of where we are headed. We may hope to, possibly, get married one day. We may or may not have family goals. Or we may be beyond that stage and thinking about the future needs of our children.
Alternatively, we may be tempted to move in a whole new direction, to travel the world or reimagine our retirement.
Things often happen outside of our control. Circumstances change and sometimes our ambitions too.
It’s why growing your wealth is a helpful one-size-fits-all goal. It’s about maximising your options as you navigate your way through life.
Unless you’re very lucky, you need to save. Your future self will thank you for it.
And the more ambitious your goals, the more those hard-earned savings need to work for you, which is why you should consider investing those savings.
Simply leaving your money as cash will do little to counter the corrosive effects of inflation and preserve, or better still, increase its future buying power. This is true even with the increases in interest rates we have seen over the past year. You want your capital to grow in real – or inflation-adjusted – terms.
Consider the chart below. The red line gives you an indication of the returns you would have received from holding £10,000 in cash on deposit since 1998. Not great but not terrible either. However, it’s the other line that matters, because that shows what these returns would be after accounting for inflation.
Returns from cash, before and after the effects of inflation
Notes: Cash returns represented by the Intercontinental Exchange (ICE) Libor GBP 3-month benchmark; inflation by the UK Retail Price Index.
Source: Factset, Vanguard calculations based on period 31 December 1998 to 30 November 2022.
That’s the degree to which inflation can eat into your cash returns, especially when inflation is higher than interest rates, as has been the case for the last decade – and more so this year as inflation has raced higher.
Risk and return
The key difference between simply saving and investing are the trade-offs between risks you are willing to take and the returns you could potentially earn.
If your goal is in the very near future – say, you're paying for a wedding in six months' time – you'll want to protect your money away from the ups and downs of markets.
Money you have set aside to cover a potential emergency or ‘rainy day’ should also be kept as cash. (We suggest having enough to cover at least three months of outgoings).
But the problem with seeking safety is that it doesn't give you the potential for higher returns. And the lower your return, the more likely your savings will be eroded by inflation, which means your money could be worth less in future.
So if your goal is sufficiently in the future, then you need to give your money a better chance to outpace inflation. This is where investing can help.
Thinking about your goal can also help you to decide which tax-efficient wrapper to invest with – whether a stocks and shares individual savings account (ISA) you can withdraw from at any time or a self-invested personal pension (SIPP) that locks in your money until you’re at least 551.
In the next article in this series, we’ll consider Vanguard second principIe – being balanced – and explain the different risk-reward tradeoffs when you invest in shares and bonds.
1 Rising to 57 in 2028.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
This article is designed for use by, and is directed only at, persons resident in the UK.
If you are not sure of the suitability or appropriateness of any investment, product or service you should consult an authorised financial adviser. Please note this may incur a charge.
Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.
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