Saving money from a monthly paycheck is always a good idea, but are value stocks a better destination for these funds?
Having some extra cash at hand provides a lot of flexibility. Beyond being able to enjoy some retail therapy, it also provides a soft landing should things suddenly take a turn for the worse. Yet, could having too much in savings actually be harmful? Let’s take a closer look.
Savings create opportunity cost
Putting money in the bank guarantees two things:
- Safety – banks are heavily regulated to protect depositors from risk. And even if an institution still fails, up to £85,000 is insured by the FSCS per bank.
- Returns – banks pay depositors interest to reward them for leaving their funds untouched.
These factors make them close to a completely risk-free investment vehicle. However, as with most things in life, the lower the risk, the lower the reward. Even today, after the Bank of England aggressively hiked interest rates from 0.1% to 5.25%, savings accounts still lag the average returns generated by other instruments, such as the stock market. And this is where an opportunity is created.
Looking at the FTSE 250, investors have reaped an average 11% return each year since its inception. That’s more than double the best savings accounts currently offer. And when compounded over decades, investing a couple hundred pounds a month could lead to a nest egg worth hundreds of thousands of pounds, or more.
This is especially true in 2024 since many individual companies are still reeling from the recent market correction. As such, there are plenty of top-notch value stocks trading at a significant discount today. And by capitalising on these bargains, investors could potentially unlock even greater returns.
Risks and opportunities
While the stock market can profoundly improve individual wealth, it sadly doesn’t have the same level of protection compared to a bank. In fact, it carries significantly higher risk. And those who are ill-prepared may end up underperforming a bog-standard savings account. Perhaps they’ll even accidentally destroy their wealth rather than create it.
There are a lot of unknown factors at play in the stock market. And even the most prepared investor can still make some costly mistakes. Warren Buffett is known to many as the greatest investor in the world. Yet even he has admitted to making countless errors along the way.
The good news is that while risk can’t be avoided, it can be managed. Risk management is a bit of a complex beast. And financial institutions have entire departments dedicated to just that. However, not all strategies are difficult to employ. In fact, one of the easiest and most powerful is diversification.
By owning a wide range of high-quality enterprises that operate in different industries and countries, the risk profile of a portfolio can be reduced. This remains true even for those venturing into the realm of penny stocks. Why? Because if one firm were to be disrupted, the others are less unlikely to be affected and can offset the negative impact.
