Many people still fail to understand the difference between saving and investing. With savings rates at historic lows, that’s a costly mistake to make.
Saving involves leaving your money in the bank or a Cash ISA, where you will be lucky to get 1% on instant access. There is little sign of today’s low interest rates picking up either, and they could stay this low for years to come.
Investing means putting your money into stocks and shares, and other riskier assets, in the hope of generating a higher return. Shares have thrashed cash over the last decade, and I expect their success to continue.
Last year, the FTSE 100 grew almost 12%, and paid dividends worth around 4.5% a year on top. Despite this, many companies on the index still trade at low valuations, and some yield more than 7%. Returns like these could dramatically boost your long-term retirement prospects.
Which is why I would invest my money in a Stocks and Shares ISA, instead of saving.
Cash offers near-zero returns
This financial year you can invest £20,000 in an ISA allowance. Let’s say you put it all into a Cash ISA that pays on average 1.5% a year for the next 10 years. At the end of that, you would have £23,211, giving you a profit of £3,211 (although its real value will have been eroded by inflation).
It’s a different story if you invest your £20k in a Stocks and Shares ISA instead, buying for example a FTSE 100 tracker that matches its historic average total return of 7% a year. After 10 years, you would have £39,343, with all dividends reinvested for growth.
In this instance, your profit would be £19,343, six times as much. The longer you invest, the greater the differential is likely to be.
Stocks and shares are more volatile than cash in the short run, but over the years, the bumpiness smooths out, and they provide a vastly superior return. That is why I invest my retirement funds, and leave only a small emergency fund in cash savings.
This bull run could continue
The global stock market bull run has lasted more than a decade now. At some point, there will be a correction, there always is. If that happens, all you have to do is sit tight, and wait for the recovery. It always comes.
As well as the FTSE 100, I invest in the US and emerging markets, which allows me to benefit when overseas shares rise faster than our own.
You can invest via funds, or individual stocks and shares. Funds do a better job of spreading risk, as they may contain dozens or even hundreds of stocks. Individual company shares can turbocharge your returns, but always you buy a spread of them, across different sectors of the economy. That way, if one or two struggle, others should compensate.
This should reduce the risks of investing, while generating the kind of returns you will never get from saving.
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Harvey Jones 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.