I recently saw a piece from the BBC that suggested that savings beat the stock market.
If £1,000 was invested at the start of the decade, it would now be worth £1,094 in an average UK unit trust but £1,358 in a typical savings account.
Well, I’m afraid this is just trivial. In fact it’s worse because it perpetuates the general financial ignorance in this country. Why is it trivial? Because we expect shares to beat cash over the long term but not every year or at any point we choose at random.
It is impossible to predict which of the major asset classes will be the best performer from year to year. Some years interest rates are high and cash in a savings account will do very well but the next year rates might plummet and bonds might perform well. Similarly if you had put your money in residential property in the UK over the last decade you would have done very well indeed – until recently.
Different asset classes can offer non-correlated returns. In other words, you don’t want all of your assets going down at the same time so you invest in things that tend to behave differently. The fact that the returns are non-correlated actually reduces your financial risk.
Now imagine that you are about to retire and you have all of your money in buy-to-let property. If you got in ten years ago then you’re still a happy camper but if you got in just a couple of years ago then you might be rather annoyed. Now imagine instead that you have 20% in cash, 30% in bonds, 25% in the stock market and 25% in property. It’s a bad time for stocks and property so you can leave them invested until they recover. In the meantime you can live off your cash and bonds. By diversifying you give yourself time to ride out the peaks and troughs.
You can also drip feed your investments into the market to avoid making timing errors i.e. automatically avoid buying everything at the top of the market. This is called pound cost averaging. Of course, if you had invested a lump sum in property at the peak of the market in the eighties you would still be doing very nicely now – much better than if you had invested via pound cost averaging. The length of time over which you intend to invest has a major impact.
The point of this piece is not so much to defend the stock market – there are more than enough bankers around to do that already – I want to point out that the previously great BBC is churning out trivial nonsense. We need some proper financial education in this country but in the meantime how about some proper financial journalism from the BBC instead of irritating dis-information nuggets. Reading that last sentence again I think I probably need some grammar and spelling lessons.