As if we didn’t have enough to worry about, interest rates on savings have been cut yet again this year. Unbelievably, the ‘best buy’ Cash ISA rate I could find at the time of writing was just 1%, according to Moneyfacts. You probably won’t be surprised to know that I’m buying FTSE 100 shares instead of saving cash.
Today I want to explain why I’m confident that stock market investing will improve my chances of retiring early.
What rich people don’t want you to know
I admit that cash savings are essential to protect you from unexpected mishaps and meet short-term commitments, such as bills and holidays. But saving in cash will rarely do more than allow your money to keep pace with inflation. The real value of your savings – after inflation – is unlikely to rise, and may fall.
The reality is that people who become rich rarely do so by hoarding cash. They understand that money is not a productive asset. What money does is enable you to acquire assets which do generate wealth.
Of course, this comes with some risk. Investments can and do go wrong. But over longer periods, with suitable diversification, history suggests it’s possible to build wealth without taking too much risk.
Safe and boring FTSE 100 shares
One popular misconception is that you have to invest in small, risky companies to make money. Nothing could be further from the truth. Good quality, mature businesses can provide excellent returns.
A £5,000 investment in FTSE 100 consumer goods group Unilever five years ago would be worth about £7,500 today. In addition to the rising share price, you’d also have received around £1,000 in dividends. That’s a total return of around 70%. In five years.
Profit despite market crashes
Even when investments go wrong, you can still earn acceptable returns over time. A good example is the FTSE 100 index itself, which you can buy easily and cheaply with a FTSE 100 index fund.
This year has seen the biggest stock market crash since the 2008 financial crisis. But as I write, the FTSE 100 is only down by around 6% from five years ago. On a £5,000 investment, that would be a loss of about £300.
However, if you had bought the FTSE 100 five years ago, I’m pretty sure you’d actually be showing a profit today, thanks to your dividend income.
I can’t get the exact figures, but if we assume an average yield of 3.6% over the last five years, then you’d have received around £900 of dividends from your FTSE index fund. After subtracting the £300 market loss I mentioned above, you’d have a net return of £600.
A £600 return on a £5,000 investment is equivalent to a 12% gain. That’s a bigger return than you’d have managed in cash savings, even though the market has crashed.
FTSE 100 shares need patience
The lesson here is that a patient, diversified approach to investing can deliver impressive results without too much risk. By leaving your money invested in the stock market for years, you can build the kind of wealth that could help you retire early.
Of course, even FTSE 100 shares can provide a rough ride sometimes. Learning to ignore short-term volatility is the price you have to pay to secure attractive long-term gains. I think the potential rewards are worthwhile.
