Investing is probably one of those things you know you “should” do, but perhaps you are not entirely sure why. In this article we explore some of the top reasons to get started with investing, which for most people is to beat the inflation rate and grow their wealth.
We’ll start by looking at the differences between saving and investing
When you put your money in a savings account, you park your money with a bank. The bank will give you an interest rate, which at the time of writing typically ranges from 0 - 1.5% per year. While in many cases the bank is able to adjust the interest rates from time-to-time, the pound amount in your savings account won’t go down. A savings account is suitable if you are saving for a short-term goal, such as an upcoming holiday, or if you don't have much of a financial buffer yet and are building an emergency fund for a rainy day.
One of the reasons people invest is to beat the inflation rate, especially now that the interest rate on savings accounts is lower than it has been in many years. One of the major downsides of leaving all your money in a cash savings account is that while the pound amount in your savings account won’t decrease, the real value can decrease.
For example, goods and services that cost £1,000 in 2000, would set you back £1,785 today, as the inflation rate averaged 2.8% each year between 2000 and today. This means that prices on average increased by 2.8% every year. You can find more details about the inflation rate in the UK here.
In other words, had you had put £1,000 in a savings account in 2000 with a 1% annual interest rate, you’d have had £1,232 in your account today and you’d have been worse off today as you could buy less than what you could have in 2000.
Had you invested the same amount in the S&P 500 - a fund tracking the US’s largest companies, more explanation here - you’d have £3,745 today.
This leads us to the second point. Most people invest to get financial returns.
Historically, returns on investments in the stock markets have outperformed returns on savings accounts. In the above example, if you had invested £1,000 you would have had £3,745 in your account today - that’s plenty of money to buy what you could have bought in 2000, as well as some nice return. Had you put in £1,000 and deposited an additional £300 each month, your account value would have been worth over £240,000!
Historically and over the long run the market has gone up, but it is important to remember that the value of your investments can go up and down from day to day and will fluctuate more than savings, which is why investments are more suitable for longer term goals.
One last factor to keep in mind and why investing can be so lucrative is compound interest.
Say, you start with £1,000 and the value of your investment portfolio goes up by 10% each year. In your first year, you will have a £100 return and you’ll have £1,100, and the 10% return in the next year will be over the new amount, meaning that in the second year the return will be £110 and so on.
Aside from investing in the stock market, you can also consider adding alternative assets to your portfolio, particularly if today you’ve already invested most of your money in the stock market. Alternative assets can encompass anything from real estate and startup investing to investing in collectibles or cryptocurrency. You can find out more in our beginner’s guide to alternative investments.
In this article we’ve covered some of the reasons to get started with investing: beating the inflation rate, making financial returns and how those returns over the long-term add up due to compound interest. Next up, read more about popular types of investments and their pros and cons.
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The articles and information made available on Koia are provided for information and educational purposes only and do not constitute financial advice. You are advised to consult with an independent financial advisor for advice on your specific circumstances.