If you’re looking for a safe home for your cash, then the obvious choice is a Cash ISA.
Obvious, but probably wrong.
Today’s ultra-low interest rates mean that most cash savings accounts will cause you to lose money each year.
The maths is simple. UK inflation is currently 1.7%. That’s the estimated increase in the cost of living each year.
In contrast, the best easy access Cash ISA rate I could find at the time of writing was 1.45%.
If the interest rate on your savings is less than the rate of inflation, then the purchasing power of your money is falling each year. In real terms, as economists say, you’re losing money.
Yes, but…
Don’t get me wrong. I have cash savings and I believe they’re essential as an emergency fund and for money that you might want to spend. For example, savings for a holiday or your children’s university fees.
The mistake is to confuse saving with investing. With interest rates so low, saving cash is effectively just putting it in a pot and keeping it safe until you need it.
Investing means putting your money to work in the hope that it will increase in value.
You could earn 87% more from stocks
One of the secrets to getting rich is to make the power of compound interest work for you. Compound interest simply means earning interest on previous years’ interest.
Compound interest can be incredibly powerful. Alfred Einstein once described it as the “eighth wonder of the world”.
To try and show how much difference compounding can make to your savings and investments, I’ve calculated some examples to show the returns you could expect for different types of investment.
I’ve based each example on an initial investment of £1,000:
|
Saving/investment |
Annual return |
Value after 5 years |
Value after 10 years |
|
Best buy easy access Cash ISA |
1.45% |
£1,075 |
£1,155 |
|
UK CPI inflation |
1.7% (Sept 2019) |
£1,088 |
£1,184 |
|
Best buy 5-year fixed rate ISA |
2.01% |
£1,105 |
£1,220 |
|
Conservative long-term stock market estimate |
5% |
£1,276 |
£1,629 |
|
Long-term average annual return from UK stock market |
c.8% |
£1,469 |
£2,159 |
The numbers are pretty compelling, in my view. Put your money into the stock market and reinvest the returns each year, and you could see a profit of £1,159 over 10 years.
If you stick to cash, then at current interest rates you’ll earn just £155 over the same period.
What could go wrong?
You probably don’t need me to tell you that stock markets can go down, as well as up. Over a five- or 10-year period, there’s no guarantee that your returns will match the long-term average. This is why it’s so important to only invest in the stock market with money you won’t need for at least five years, preferably longer.
Over the short term, the stock market can be a scary place. But over long periods, history suggests that investors who remain patient and stay invested will enjoy decent results.
