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Is it time to invest in the stock market?

Joanna Faith
Written By:
Joanna Faith
Posted:
Updated:
11/01/2013

Savers hiding in the illusory safety of cash could be putting themselves at significant risk.

It has been a mixed week of news for savers. There was both surprise and relief that changes to the retail prices index (RPI) were ruled out. If brought in, the new rules could have had a drastic effect on peoples’ nest eggs.

However, savers were dealt an albeit expected blow when interest rates were kept at 0.5%.

This is the fourth year Brits have had to contend with the record low rate and the future doesn’t look much brighter. Banking giant Citi warns rates are likely to stay at 0.5% for the next four years.

Citi has also cut its 2013 growth forecast for the British economy to 0.4% from 0.8% and said it expected growth to remain weak – at about 0.7% – in 2014.

The fragile economic environment leaves some difficult questions for savers. The stock market may seem a scary proposition, especially for the more risk-averse. However, keeping money in cash is hardly an appealing prospect either. The current economic state-of-play has put savings rates at their lowest levels for 300 years.

Cash is often the go-to destination for risk-averse savers, mostly because it is quick and easy to access in an emergency and in the five years since the credit crisis, even the most seasoned savers have fled to the perceived safe haven of cash.

However, cash as an asset is not risk free. Aside from the obvious risk of the underlying bank collapsing with inadequate safety-netting, such as we saw in the Icelandic banking crisis in 2008, there is also inflation risk, the risk that the interest earned is not sufficient to keep pace with rising prices.

“The problem with cash is the value depreciates over time and loses its spending power,” says Danny Cox, head of advice at Hargreaves Lansdown.

Over the last 25 years the rate of inflation has averaged over 5%, yet savings account have averaged just over 3% over the same 25 year period.

So is the stock market the solution?

Ben Seagar-Scott of Bestinvest says it depends on a saver’s risk appetite.

He says: “When thinking about saving and investing, it’s always important to consider risk. For investing, the main risk is capital risk from the investment, the risk of actually losing money. Generally speaking, investments that have a higher potential to grow also have a higher potential to shrink and so are considered riskier investments. If you invest £1000, you would be unhappy if you got back less than £1000.”

While many savers have played it safe over the past five years, figures shows they would have been better off investing in bond and equity markets.

Data from Fidelity Worldwide Investment shows savers would have earned an extra 7.99% over five years if they had invested the Fidelity MoneyBuilder Income, a bond fund and 3.05% in Fidelity’s MoneyBuilder Index fund.

Tom Stevenson, investment director at Fidelity, says: “The world economy continues to go through a tough time and markets are likely to remain volatile, so the flight to safety is understandable. However, in an environment of low growth and low interest rates, hiding in the illusory safety of cash could itself be a significant risk.

“Accepting inevitable ups and downs of equity and bond markets, investors can benefit from the long term outperformance of shares and bonds while still reducing the risks of investing with a few simple measures.

“For example, saving small amounts on a regular basis can help to combat the natural tendency of investors to sell when markets are low and buy when they are high. Diversification is also important; bonds and equities can move in different directions and owning a balanced portfolio can smooth returns.”

Before making any investment decision, savers need to understand their risk appetite. Nick Hill at the Money Advice Service provides the following three steps:

Step 1: know what you can afford to lose – Ask yourself what would happen if you lost some/all the money you invest, and think about people who depend on you financially and any other important financial commitments you need to be sure of meeting.

Step 2: work out your goals and timings – The bigger your goal, in relation to the assets or income you wish to invest, the greater the rate of return required to beat inflation and hit your goal. Taking no volatility risk at all may make your goals impossible to achieve, taking too much may lose you your investment.

Step 3: understand your personal risk attitude – Your capacity for financial loss and the nature of your investment goals are most useful in determining a good balance of risk for you. A qualified professional adviser must assess your risk appetite before giving you any investment recommendations.