The idea of everyone being able to invest their savings in funds that offer a real return above interest is certainly a hopeful one, but is it realistic? Can you safely invest your savings whilst also taking advantage of the stock market? Can you have your cake and eat it?
According to Thisismoney.co.uk, the banks are returning to offering ready-made investment products following years of low-interest rates as a way to “help” savers.
In this blog, we’re going to cover the fundamentals of investment, weigh up the risk and reward of some of these high street bank investment products, and see whether we can decide if they’re a sensible place for you to put your hard-earned money.
How does investing work?
In the simplest possible terms, investing is the idea that you can buy a product at one price and then sell it for a higher price at some point in the future. This product could be an old car, a bottle of whisky, a playing card, a piece of memorabilia from a film or TV show, or really anything at all. If you buy something with the expectation that you will be able to sell it for more than you bought it for, that purchase is an investment. Although these examples can be very lucrative, (in 2017 a Star Wars figurine was sold for £21,600) when most people talk about investments they are thinking about shares and the stock market.
So, how does investing in the stock market work? This question is far too complicated to answer here, but the essential idea is just the same as our other examples; you buy a stock, it grows in value, and you sell it for more than you paid for it. Let’s look at an example:
Based on this example, do you think Dan made a good investment? At first glance the answer might seem to be yes, but is it really that simple? To answer that question, we must turn to our next topic.
The First R: Real Return
If I walked up to you on the street and said I could change your £10 into £15 right there and then with zero risk, you’d immediately jump at the opportunity. Now, if I said I could take £10 and turn it into £15 in five years’ time, what would you do? You might think about what you could do with that £10 right now and whether the future promise of an extra £5 was a more attractive option, but you probably wouldn’t think about macroeconomic growth and price inflation.
This is complicated stuff, but you’ll know what it means in practice. £15 today buys less than £15 bought 10 years ago. This is why Freddos no longer cost 10p, and it’s also why your grandparents bought their first house for less than you might have to pay for a second-hand car. What you, therefore, need to work out is how much £10 buys you today and how much those same items will cost in 5 years’ time, and you should only take my deal if the answer to this second question is less than £15.
Economic growth in the UK has averaged 2.33% over the past 50 years so – if this trend continues – a shopping list that costs you £10 today will cost you about £11.22 in five years’ time. Real return is what we call the profit you make on an investment minus the effect of economic growth, so, whilst turning your £10 into £15 has made you £5 profit in absolute terms, in real terms my investment only made you £3.78. Still a pretty good deal though.
The Second R: Risk
Real return is not the only complication to my offer though. What if I told you I was only 50% sure I could turn your £10 into £15? How about if I said I was 10% sure? These questions bring in the idea of risk which is an unavoidable reality in any kind of investment. It’s time for another quick diagram here:
This diagram shows there is a tradeoff between risk and real return. If you put your £10 into a savings account then there is hardly any risk of you losing it, but your real return is actually negative as even the highest savings rate won’t match economic growth over time. On the flip side, if you went out and bought 10 lottery tickets then the risk of you losing that £10 is huge. The potential real return is enormous as there is a vanishingly small chance that you will become a multimillionaire overnight. My offer in the street has a positive real return but won’t allow you to retire to the Maldives so it falls somewhere between these two extremes. Where exactly does it rank? Risk is subjective, so that’s entirely up to how sure I tell you I am and your own appetite for risk.
The Third R: Rollercoaster
I promise we’re just about to get onto the actual dos-and-don’ts of high street investment, but there’s one more question that we need to ask ourselves about the nature of investment – what happens between me taking your £10 and me giving you back £15 five years later? Have a look at this made-up and simplified stock chart.
What we see here is the rollercoaster – the value of investments doesn’t always go up. We’ve already established that me taking £10 from you today and giving you back £15 in five years is a good deal, but what does this graph show?
First, it shows you that after about 3 and a half years I could have given you £25 rather than £15. This might annoy you slightly, but you’re still better off than you would have been so you probably decide that’s ok. But what if about two years have passed since our meeting in the street and you suddenly need £10 for a cinema ticket but have no money in your account? You could come back to me and ask for your money back, but I could only give you £6 back because the value of our investment has fallen. Things might even have gone so badly that the investment is worth nothing at all if the company had failed, so no cinema ticket for you.
This isn’t a threat against the dangers of investing because – if you invest sensibly – the shares do tend to go up in value in the long term. The rollercoaster analogy just shows that there’s no guarantee that you will be able to sell your investment for a profit whenever you like.
What’s On Offer?
Sorry if that all felt a bit unnecessary, but we really did need to discuss it all because these are the concepts that will help you understand the products on offer.
The most important of these is risk, as this is how all the ‘Big Five’ categorise their funds; Lloyds Bank offers three risk options, Santander four, and NatWest, HSBC, and Barclays all offer five. Naming conventions range from ‘Low Risk’ and ‘High Risk’ at NatWest to ‘Cautious’ and ‘Adventurous’ at HSBC, but all the options are differentiated by their exposure to risk. We don’t need to go into too much detail here because all the banks have detailed information about each fund on their websites so you can work out real return and look at the rollercoaster graphs to get a sense of performance.
It’s worth noting that the charges for these banks’ products aren’t appreciably lower than those for specialist providers like Hargreaves Lansdown or AJ Bell, and – whilst they have started to shed their reputation for poor performance – their returns certainly aren’t groundbreaking. If however, you don’t feel comfortable dealing with the world of high finance and you would rather stick with a brand you know and trust, these products might offer a viable and profitable alternative to putting all your money into a savings account. Even super low-risk investments will probably offer better long-term growth than a savings account, and going through a bank that you know and trust can take some of the stress out of the decision. So, onto the big question…
Should you invest?
When looking at any investment product, the question you have to keep in mind is this – given the real return they offer and my own financial circumstances, are they worth the risk?
Your own circumstances are absolutely crucial, and in the end, this is the main weakness of high street investments – it is not the ongoing charges that you need to be able to afford, it’s the potential short-term losses. In our cinema ticket example from earlier the consequences of having all your savings invested was fairly minor, but on a grander scale, the danger can be severe.
Imagine if you had lost your job in March this year just after Coronavirus caused the stock market to drop by 30%. If you had no emergency savings then you’d have been forced to sell your investments at a huge loss or take out credit just to pay your bills. You wouldn’t even have been able to claim compensation because the Financial Services Compensation scheme only comes into effect if the company goes bust, not if their stock portfolios drop in value.
The Bank of England has a page on their website called “What do banks do?”, and the number one requirement is that banks look after your money. If you put your money in a savings account then the bank will do exactly that, but the nature of risk means that the bank simply cannot guarantee the value of your investment in the short term, no matter how sensibly they invest.
How can I get started?
However, it’s not all doom and gloom for these products, because the investment is something that everyone should be doing if their circumstances allow it. Pensions are one great way to start investing. The long-term nature of a pension scheme means that you’re protected from sudden dips in the market, and by the time you can access your money it will have grown significantly. Or maybe you’ve just received a lump sum as an inheritance – look into investing that too. That money can be sitting in an investment fund growing whilst you continue to pay your salary into a savings account in case of emergencies.
In short, if you can only afford to have either a savings account or an investment fund then you’re much safer going with the savings option but – if you can afford both – why not? Whether you go with a high street bank or a specialist investor, there’s no reason whatsoever that you can’t have a savings account for emergencies and some investments to help set you up for retirement. If your financial situation allows, you really can have your cake and eat it.
Interested in finding out more?
Check out this page to have a look at our workshop on Savings and Investments.