Inflation dropped to 3.2% in the 12 months to March, down from 3.4% in February, which is lower than the Bank of England’s base rate, so currently, savers should be able to find inflation-beating savings rates.
It’s likely however that these rates could start disappearing, so many people might be considering alternatives.
If you’re looking for ways to protect your savings from inflation eroding their value, can afford to tie your money up for at least five years, and are comfortable accepting a level of risk, you may want to consider investing in stocks and shares.
Here’s what you need to know.
What are the pros and cons of savings accounts?
Saving often feels like the responsible thing to do with your money. It keeps it in a safe place where you usually can access it at any time, and where it will hopefully grow at a fairly consistent interest rate. Experts recommend keeping the equivalent of around three to six months of savings readily available in case of emergencies. Find out more in our article How to build an emergency cash buffer.
When living costs are high, savings rates often won’t keep up with inflation which can eat away at your cash. At the moment however, interest rates are currently at 5.25%, which is higher than inflation at 3.2%, so it’s possible to find savings accounts with inflation busting interest rates.
Despite this, inflation remains high and is two times higher than the government’s 2% target, and if your savings account isn’t paying a high rate, you could still be losing money.
For example, let’s imagine inflation averages 3% over the next ten years. That means something that costs you £1,000 today would cost you around £1,383 in ten years time.
But if you put £1,000 in a savings account with a 0.5% interest rate today, you’ll only earn £50 interest over the same period. So even though you’ve technically made money, its purchasing power will be much lower in a decade’s time. You will have effectively lost £333, not in the sense of literally losing it from your account, but from its value going down compared to everything else.
You can read more about the effects of both inflation and interest rates on your savings in our articles What does inflation mean for my money? and Interest rates rise: what it means for you.
What are the pros and cons of investing in stocks and shares?
When you invest in stocks and shares, there is the potential for greater rewards than you can get from a savings account over the long term, but there’s also a much higher level of risk involved.
When you buy shares, you’re essentially buying a small stake in a company, which makes you a shareholder in the business. Companies sell shares to raise money and push their business forward, and if the company performs well, the price of its shares will go up. So, in theory, if you buy a share in a company that goes on to perform very well, you could sell your share for a considerable profit.
Of course, the opposite is also true. If the company doesn’t do so well then its share prices could drop, which means that you could end up having to sell for less than you put in to begin with. Share prices aren’t strictly tied to company performance either – they can be affected by interest rates, borrowing costs, political events, the wider economy and other events (the Covid-19 pandemic notoriously sent markets into freefall when lockdown measures were first announced). Share prices can even be swayed by how well the company is predicted to perform, rather than its performance at the time. In other words, investing in shares can be very unpredictable and isn’t for the faint-hearted. Read more about investing in our article Investing – the basics.
Of course, there are steps you can take to reduce the risks involved, for example by ensuring you don’t put all your eggs in one basket. Funds can be a good way to get started with investing, as your money will be pooled together with other people and invested across a wide range of different shares and possibly other assets. This means that if one company underperforms, hopefully gains made by others will help offset some of these losses.
Drip-feeding your money into funds or shares gradually, perhaps by investing £50 or £100 a month as opposed to a lump sum, can also help reduce risk as you’ll end up buying more shares when prices are low, and fewer when they are higher, which can help smooth out market volatility.
Some shares might also offer income in the form of dividends, meaning that the business will pay the shareholders a regular cut of its earnings. Businesses that offer dividends often appeal to investors seeking to boost their retirement income.
Is buying shares risky?
The short answer is yes – while investing gives you the potential for higher rewards than savings accounts, it can also result in significant losses. Although some investments are safer than others, gains are never guaranteed. You shouldn’t put your money into anything that you don’t completely understand, and should strongly consider seeking financial advice first if you aren’t sure which investments are right for you.
The other main downside of investing compared to savings accounts is that your money is not as readily accessible when it’s tied up in shares. You’ll need to commit to selling your shares to get your money out, and even this is not an immediate process. It could take a few days for the funds to become available to you after selling.
If you’re saving in anticipation of an upcoming expense in the next couple of years then shares are probably not the way to go. In fact, most advisors will tell you that your money should stay in a share-based investment for at least five to ten years. Of course, there is nothing stopping you from splitting your money between a savings account to cover short-term and immediate expenses and shares for longer-term financial objectives, such as saving for your retirement or to fund a property purchase. If you’re saving into a pension, you will already be an investor – find out more in our guide Where is my pension invested?
Ultimately, there is no one-size-fits-all solution when it comes to investing. You will have to consider your own financial goals and attitude to risk when deciding whether to invest and how to go about it. Read more in our article Is investing right for you?
You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guide on How to find the right financial advisor for you.
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