Investing in UK shares remains one of the best methods of building wealth, and it’s far superior to simply storing cash in a bank account. At least that’s the opinion of the Financial Conduct Authority (FCA). And it’s certainly one I agree with.
In the past, hoarding cash was a prudent strategy. But in the last decade, with interest rates near zero percent, savers have actually seen their wealth shrink in terms of spending power, courtesy of inflation. That’s even more true in 2022, with inflation reaching record highs.
At the end of 2021, the FCA identified 8.6 million Britons having more than £10,000 in cash savings that could be used for investments. That’s a lot of households missing out on an average of 8% annualised return from the FTSE 100. But how much wealth is that exactly?
UK shares versus savings
Over the last decade, savings accounts have provided an average interest yield of around 0.5%. Therefore, an individual who deposited £10,000 back in 2012 would have roughly £10,512 today.
Earning £512 over 10 years is hardly anything to get excited about. But it’s still better than nothing, especially considering saving accounts are basically risk-free. This is their appeal, of course, whereas money invested in shares could rise or fall.
The problem is when inflation is taken into account. Between 2012 and 2022, inflation stood at an average of 2.5% here in the UK. And factoring this into the compounding equation reveals that my savings account after 10 years only has the equivalent of £8,186 in spending power. In other words, despite the bank balance increasing, roughly £1,814 of wealth was destroyed.
But what if they had invested this £10,000 into UK shares using a low-cost FTSE 100 index tracker? Over the same period, they’d have roughly £22,196 – more than double. And even after accounting for inflation, their overall wealth would have increased by £9,122. Multiplied across 8.6 million people, that equates to £62bn of potential wealth that could have been generated in the last decade!
Needless to say, that’s quite a stark contrast. So it’s hardly surprising to hear that the FCA is trying to reduce the number of cash hoarders by 20% before 2025.
Cash is still important
Saving cash has failed in delivering wealth-building returns. But it still has a critical role to play, even for investors.
As 2022 abruptly reminded everyone, the stock market can be a volatile place. And even some of the best UK shares have been hit hard by panicking investors.
In the long term, there’s a good chance strong businesses will survive and eventually recover before reaching new heights. But that could take a while. And those desperately needing cash to meet living expenses with no significant savings may be forced to sell brilliant stocks at terrible prices.
This risk can be mitigated by having an emergency fund stored in the bank. That’s why most financial advisors recommend holding roughly six to nine months’ worth of spending money in a savings account before investing in UK shares to build wealth.
