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Generally we invest in order to keep up with or outperform inflation. Inflation is a risk which is subtle and gradual but very harmful. Leaving money in a bank account even at what seem attractive rates raises the risk of losing substantial value to inflation over time.
If this loss is 2.5% per year, after 10 years money left in a bank would be worth 25% less than it was today – if that were an investment then you would be very unhappy with that performance.
– in a Bank – short term savings – money which is needed either to spend or to have as an emergency fund over a 5 year period at the most.
– in Stocks and shares ISAs or a General investment account – medium term savings – money which may be needed between 5 years and 20 years
– in Pensions or Life insurance bonds – long term savings – 20 years+
The difficulty in finding a starting point here is how much money you want to keep in cash, which could be anything from £5,000 to £100,000 depending on your circumstances and reasoning.
£10,000 left in a cash account for 20 years between 1993 and 2013 would have returned about £24,045 but invested in UK shares with dividends reinvested would have returned £54,127. Therefore, it could be said that leaving money in a cash account for long periods of time carries a potential risk – i.e., that the value of cash either does not keep pace with inflation or is likely to be worth less than if it were otherwise sensibly invested.
So, if we don’t want to leave too much money in cash, we then need to ask ourselves a couple of questions….
1/ What amount of cash in your bank will make you feel comfortable:
2/ How much should I invest:
When you look at an investment return in isolation it can often be misinterpreted.
For example, in one year we may have a return of +2% and in another year we may have a return of +10%.
In isolation it is easy to dismiss the +2% year and consider that the +10% year is a fantastic year.
However, when you look at a benchmark over the same period – such as the FTSE 100 (which may not be a great benchmark but is the one which everyone sees on the news)
In the +2% year the FTSE 100 may have fallen (-12%) showing a +10% out-performance of your investment to the general market, which is actually really good.
In the +10% year the FTSE 100 may have risen by +22% showing a (-12%) under-performance of your investment to the general market, which in some contexts could be viewed as quite poor.
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