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Saving vs investing – finding your formula

How should you spread your hard-earned money between savings and the stock market?

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

If you’re starting to think about tucking some money aside for your future, building up your cash savings should generally be your first port of call. If your car needs some new tyres, your boiler breaks down, or you need to switch jobs, you’ll have some money behind you to pay for it.

Everyone’s situation is different, but as a rule of thumb you should have around six months’ worth of expenses in easily accessible cash for emergencies.

Fixing your savings for higher returns

For money you don’t need to access immediately, but don’t want to invest for the long term, fixed-term savings could be the answer to improving your returns.

You can normally fix for anything from three months to five years, and the longer you fix for, the better the rate usually is. Some five year fixed terms currently pay around twice the rate you can get on some of the best easy access accounts but of course you can't access your money until the end of the fixed term.

You probably won’t want to tie up all your savings for five years, but by saving in a range of fixed terms of varying lengths you can achieve a good rate overall and still access money when you need it.

Fixed term savings can also be really useful when budgeting for future expenses, for example saving for a wedding, paying a future tax bill, or planning for school fees. If you know how much you’ll need, and when you’ll need it, you can choose a term that suits those needs.

Read transcript

Sarah: The interest rate went up in August - has that filled you with any confidence about the interest rate you'll be able to get on your savings?

Bryn: No, nothing at all. They're not going to pass it onto savers anyway are they? No, no didn't inspire me to do anything I'm afraid, I just went 'oh'.

Simon: I think you end up doing a lot of research to try and find the best return for your cash, if you're holding a large amount of cash. If you're holding a really large amount of cash I think you need to do a lot of research, because it's very difficult to get a decent cash return out there.

Sarah: The interest rate went up 0.25% in August which was great news for savers who have been waiting for a rate rise for a long time. The bad news is that this actually hasn't filtered through into the amount that a lot of savings accounts are paying, which means that people aren't getting the increase in the rates that they were hoping for.

However elsewhere in the market, so with some of the newer banks, they are actually competing for the business quite hard - so if people are able to shop around they can get a much better rate on their account.

Simon: I don't think there's an easy answer and I think the answer might be slightly different for different people due to their financial position and also their age. I have a couple of younger sons who will take much more risk, because at 23 you can, and I think as you move towards sort of retirement and thinking about it, your cash is increasing. And it is an increasing problem - where do you put it what you do with it?

Bryn: I just keep just couple of hundred pounds in a current account and about once a month I just go through and just transfer my money to a higher saver...higher interest. So I just put it into there, and then it's now building up quite a lot and I'm beginning to think I really ought to do something with this because this is more than I actually need to have in this savings account

Robert: Since I've been involved in investment or even had some cash to use, cash savings account rates have been poor so I've only ever seen it as a tool to invest with.

Mark: Okay so if you're younger probably three to six months of a salary is useful to have. You may be made redundant you may want to do a job change - it's always useful to have a backstop of a decent amount of cash. You might want even more if you’ve got a more cyclical type job or you're a contractor. If you're older I would actually say quite a lot more than that, especially around things like retirement / lifestyle changes - big lifestyle changes where you really don't know how things are going to go for the first year or so. Have more cash, you can always invest more later.

Elaine: The sad part I guess about the savings account is that they're not even earning inflation rate so it's literally eroding in value as it sits there.

Alex: What would the direct risks be from just a cash account?

Sarah: People look at their savings account statement each month and look at the money they're making as pure profit but they're forgetting the impact of inflation so for example you had £100 sitting in a bank account for the last ten years then that would actually only have the buying power about £80 today. So it's important to do what you can to reduce the impact of inflation. One smart strategy is to break your money up into savings pots so you have some available for emergencies in an easy-access account, and then you tie up some more for longer periods in a fixed account which will offer you higher interest in return. In that way you can boost your overall returns.

Robert: I know rates aren't great with it but you know it's the old adage of cash is king and you know, if you haven't got that cash if you haven't got that ability to make decisions and actions very very quickly then I think that is risky.

Mark: So cash is really there to give you loads of flexibility?

Elaine: Yes exactly, yes as and when we find we need it, there is money there for us to tap into.

Robert: A lot of people see cash as the risk mitigator and for no other reason.

Alex: Most of my money is in investment to be honest, I don't hold much cash.

Mark: So within a portfolio well really cash is just part of an overall position. It's an asset class so, again, it really depends on your own feelings towards risk or reward. But if you've got more money in emerging markets, in Asia, you might want to have more in cash. Actually it kind of reduces the volatility of the entire portfolio - once again it gives you optionality. It allows you to invest more money maybe at a later time so the markets take a big dip, it actually allows you to put some more money in so cash is really useful for that so don't think if cash is just being a poor returning asset just because interest rates are low right now think of it as being a big advantage within the portfolio.

This video is not personal advice to invest in any of the investments mentioned. If you are unsure whether an investment is right for you, please seek advice. Active Savings helps you make your own decisions and is not personal advice. Fixed term products generally only allow access to funds at maturity. Inflation reduces the future spending power of money.

If you’re looking to boost your fixed term savings our Active Savings service could be the answer. It lets you pick and mix savings from different banks and building societies through one online account, without any paperwork or hassle.

Discover Active Savings

Inflation – the hidden danger

But while cash savings won’t fall in value, they aren’t actually risk free. Cash often struggles to keep up with inflation (rising prices), so you can lose money in real terms.

Something that costs £1,000 today will cost £1,027 in a year’s time, because inflation’s currently at about 2.7%. After 20 years of 2.7% inflation, your £1,000 will be worth just £578 in real terms.

Using fixed-term savings with a higher interest rate can help mitigate this, but for money you’re happy to set aside for the longer term, it’s well worth considering investing in the stock market if you're happy with the risks involved.

Investing in the stock market could boost your returns

Research from Barclays shows that over the last century, the stock market has generally done better than cash. And the longer you invest for, the better your chances. Invest for ten years and your chance of beating cash returns is 91%. Remember this is based on historical data so isn't a guide to what you'll get in future - there are no guarantees. Investments fall in value as well as rise so you could get back less than you invest.

Companies exist to make money for their shareholders, and by investing in the stock market you’re becoming a shareholder. You’re entitled to a share of any profits a company pays out as dividends, and you could see the value of your shares rise too.

Of course it’s not a one way street – companies don’t always succeed and shareholders can lose money. That’s why it’s a good idea to hold shares in a number of different companies, to avoid having all your eggs in one basket.

It’s also why we always say investing is for the long term. It’s hard to predict the stock market’s rises and falls in the short term – and if you’re likely to need the money in the next five years, cash is usually your best option.

But if you’re investing for five years or more, you have the time to hopefully ride out the ups and downs, giving you a better chance of making money overall – though it’s never guaranteed.

Number of consecutive years
2 3 4 5 10
Outperform cash 80 82 84 86 99
Underperform cash 37 34 31 28 10
Total number of years 117 116 115 114 109
Probability of equity outperformance 68% 71% 73% 75% 91%

Past performance isn't a guide to future returns

Source: Barclays Equity Gilt Study, 2018

If you’re looking for an easy way to get started with investing, our Simply Invest service could be worth a look.

This tracker fund lets you buy a small slice in about 650 UK companies, large and small, all in one investment. Because there are no fund managers to pay, the fund charges are ultra-low, and this means more of your money stays invested. If you want to invest, we'll send you regular updates on how your investment's doing and tips on making the most of your account.

Like all investments it’ll fall as well as rise in value so you could get back less than you invest.

You can start from just £25 a month, or a lump sum of £100.

Find out more about Simply Invest

This article isn't personal advice, but could help you make your own decisions so you can make more of your money. If you are unsure of the suitability of a product or investment for your circumstances, please seek advice. Inflation reduces the future spending power of money.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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