If you have no savings by the time you’re 40, it may be tempting to go for an especially low-risk product. Returns might not be the greatest, sure, but at least you can protect what little you have put away for retirement.
You don’t want to find yourself having lost your capital 10 years down the line by investing in riskier assets, right? You might not have the time to make that up.
Saving and investing as we know involves the weighing up of risk against possible return. In my opinion, locking your money up in a low-yielding cash account is weighted far, far too close to the sheltered end of things. By the time the average 40-year old intends to retire, say, in 25 years, saving here is unlikely to have made them the sort of returns they’ll need to retire in comfort.
Let me illustrate just how bad the returns are for cash savers. Assuming you want to keep you money locked up in a five-year fixed-rate savings account to give you access to a better interest rate, the best-paying of these accounts is offered up by Aldermore and boasts a rate of 2.25%, according to Moneysupermarket.com.
You open the account with a initial deposit of £10,000 and over the life of the product you put an extra £250 into it a month. Want to know how much you’ll earn in interest in five years? A paltry £2,028.29. On a total investment of £25,000. Ouch.
Want to know the sucker punch? This interest is worked out on a gross basis. By the time the taxman takes his share you’ll be left with an even-smaller pot. And you can forget about Cash ISAs too. These products may be more tax efficient but, with interest rates remaining below 1.5%, they’re unlikely to generate the sort of returns allowing you to retire in comfort.
Investing in smart stocks
This is the part where I explain how buying up stocks and shares is a better way to make money for your later years.
The beauty of those cash accounts is that, barring the unlikely event that the bank or building society where your money is deposited goes skint, you know exactly how much you’ll end up with at the end of the term.
Unfortunately, the nature of stock investing, where market behaviour is constantly shifting on a sea of conflicting macroeconomic and geopolitical factors, means it’s impossible to accurately predict what return you’ll make on your cash. And especially not on a short-to-medium-term basis (up to five years, let’s say) where extreme market volatility can take a bite out of your returns.
However, over the long term (10 years or more) it’s likely that you’ll make much, much more money than if you parked your surplus capital in a cash account. And there’s plenty of people out there who will attest to this.
Now let’s consider that 40-year-old with his £10,000 initial investment and extra monthly contributions of £250 again. Over the space of 25 years, this person would make a total return of £295,732.49 on a total investment of just £85,000. And this is assuming the average annual return comes in at the lower end of the proven 8-10% range. With the right strategy, it’s clearly possible to still make a fortune within just a few decades.
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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.