Savings and investments explained
You should always try to hold some of your money as cash. But if you keep all of it in a savings account, inflation can eat away at it – especially when interest rates are low. So over time a given amount will buy less and less.
Investing is one way of trying to beat inflation. It gives your money the potential to grow or generate an income at a higher rate than cash over the medium to long term (at least five years). As with any investment the value of your fund can go up or down and may be worth less than what was paid in.
Figures are illustrations only.
These don't take in to account any charges that may apply.
Inflation vs saving and investing
If inflation was 4% a year for 10 years, prices would increase by 48%. You'd need £148 to buy goods that had cost just £100 ten years earlier.
If you'd put £100 in a savings account and earned 2.5% a year for 10 years, you'd have just £128 at the end (before tax). Your savings haven't kept up with inflation - although your capital is generally secure in a bank or building society.
If you'd invested £100 and it grew at 7% a year, you'd have £196 after 10 years.
You can invest in all sorts of things
There are four main types of investment, called asset classes. There's no "best" one – they have pros and cons. Click each one below to find out more...
Deposits held in bank and building society accounts.
Low risk, but inflation can erode its value when interest rates are low. However capital is generally secure in a bank or building society.
Loans to the government or companies. Normally pay a regular income until maturity. Usually viewed as safer than shares.
Residential or commercial buildings. Often seen as riskier than Bonds but less risky than Shares, and values rise and fall. Can be hard to sell.
A stake in a company.
High risk. Prices rise and fall but historically over the long term they have tended to perform better than the other asset classes.
Cash in more detail
The lowest risk asset category is cash because its value normally does not go up and down, and your savings increase through the accumulation of interest. However, interest rates will tend to go up and down, usually linked to the Bank of England base rate.
Cash is not completely risk-free as its purchasing power can be eroded by inflation and the bank or building society could run into difficulty. The Financial Services Compensation Scheme was put in place to protect savers from such a risk by protecting up to £50,000 held directly in a bank or building society savings account.
While cash is an essential part of everybody's investment mix, you should consider holding some of your savings in other assets that have potential to grow so they can keep pace with inflation.
Please be aware that you can also invest in cash-based investment funds often referred to as money market funds which are not as secure as bank or building society accounts.
Bonds in more detail
There are two common types of bonds, Government bonds and Corporate bonds. Bonds are issued when a company or a government want to borrow money from investors. They are normally issued for a fixed period and they pay back a fixed rate of interest each year, until the investor receives their capital back. You can invest in bonds by buying directly but the more common way to invest in bonds is through a fund.
The more secure the government or company that issued the bond, the less risky the investment tends to be – because there is less chance of them not paying your income or giving you your capital back. The income (commonly referred to as the yield) paid on bonds will normally reflect not only the credit rating of the government or company issuing the bond, but also current and expected interest rates. For overseas bonds, changes in the foreign currency exchange rates may also affect returns (sometimes significantly).
In addition, bonds that have a short time until they mature (say less than 1 year) tend to be safer than those with a long time until maturity (say longer than 15 years), which can be quite volatile. If you need to sell a bond before its maturity, it may be worth less than you paid in.
Property in more detail
Many people regard their own homes as an investment, although realising the value of this investment can be tricky unless you are prepared to downsize.
Buy-to-let properties are another alternative or there are commercial property funds, which invest in different types of business property, including shops, offices and industrial premises.
However, as the recent past has shown us, property values do fluctuate significantly.
You can invest in property directly, or through a fund (or both). But irrespective of how it is bought, it can sometimes take a long time to sell, which means that you may not have instant access to your investment.
On the plus side, property can be a sound long-term investment, providing regular income and the possibility of real growth in value. It does not tend to behave like other investments such as equities and bonds. Therefore, investing in property is a good way to diversify your portfolio.
Shares in more detail
Most people invest in shares to try and get a better return than safer investments such as bank deposits.
Returns from shares can be from dividends and/or changes in the share price. The value of shares can of course fluctuate depending on factors such as current and anticipated future performance of the company, investor sentiment, the political and economic environment, inflation etc.
You can spread the risk by investing, via a fund, in a variety of different shares within different sectors and countries.
Funds: easy way to start investing
When you invest in a fund your money is pooled with other people's – together you can buy many more types of asset than you could on your own. This reduces the risk of buying one asset and it doing badly. Investing via funds reduces the overall risk of investing in an asset class, because you're not investing in just one property or just one company. A professional manager decides what to buy, based on the aims of the fund. Funds can aim for growth, capital protection or income, invest in one asset class or several, and invest in the UK or abroad. You choose the type of fund you want to invest in.
Can invest in asset classes such as Money Market Instruments (including cash), Bonds, Shares and Property.
Risk vs return
When it comes to investing, you need to balance risk and return. In general, the less risky the investment, the more likely you are to get your money back but the less the potential for growth. The more risk you're prepared to take, the higher the potential return usually is.
You need to assess your own attitude to risk, and invest accordingly (taking financial advice when you need). Some people are comfortable only with low-risk investments. To spread your risk, you should consider investing in different investments and asset classes. Then you won't need to rely on the performance of a single investment or asset class. As with any investment the value can go up or down and may be worth less than what was paid in.
Investments may be volatile
As with any investment the value can go up or down and may be worth less than what was paid in. Their performance is affected by a number of things, such as economic conditions, a company's profits and the exchange rate (if it's a foreign investment).
Over time the effect of these peaks and troughs tend to be smoothed out to some extent, which is why investing is generally seen as a long-term activity.
Because of these fluctuations, investing regular amounts rather than lump sums can be a good idea, as you end up paying an 'average' price, which means you reduce the risk of seeing an immediate fall to all of your capital. What matters, though, is how much your investment is worth when you cash it in.
A volatile investment – the value fluctuates with extreme highs and lows.
A steadier, less volatile investment. The ups and downs are less extreme.
If you needed your money back at this point, the higher risk investment would be worth less than the lower risk.
If you don't need access to your money in the short term, the more volatile investment could end up being worth more.
To sum up...
- Holding all your money in cash is not always the best option in the long term – inflation can mean your purchasing power may decrease
- Investing is a way to try and make your money grow more than if you held it as savings in a bank or building society. Although capital is generally secure in a bank or building society
- There are four main types of investments, called asset classes: cash, bonds, property and shares
- You don't have to invest in them directly – by investing in funds, your money can be spread across different investments, reducing the risk of having everything in one place
- Funds, like their underlying investments, have different degrees of volatility – the amount that their value goes up and down
- You need to balance risk and return. In general, more volatile investments have the potential for higher returns over the long term, but they are more likely to suddenly fall or rise in value
As with any investment the value of your fund can go up or down and may be worth less than what was paid in.