Why you may be losing money every second

Photo ID: 96676234 by pterwort on shutterstock

We have all been told to save. It starts when we are young children. We are given our first piggy bank and are told that if we save our money then one day we will be able to buy something big with it. The same applies when we get our first job. “Save 20% of your gross income each month” and soon enough you can afford a house deposit. It makes sense, save a little every day over time and you end up with a stockpile of money. Easy enough, right? So what’s wrong with this picture?

Well, it’s not that simple. And this is the part that we don’t really get taught from a young age, but we should.

Let’s say you started off with £20,000 in 2007, what would that saving have amassed to over 10 years? It depends on how you had saved that money. So let’s compare a few options:

Option 1:

You put your cash into a basic current account and didn’t touch it for 10 years so your £20,000 would still be, well £20,000.

Option 2:

You put it in a savings account and gained interest and your £20,000 grew to about £25,000.

£5,000 without lifting a finger. Happy days, right? Maybe not once you consider inflation.

You probably know that inflation means that goods become more expensive over time. But how can this affect your investments? Essentially it means that you need to earn more to have the same spending power.

For example, imagine that in 2007 a watch cost £1,000. With £20,000 you could have bought 20 watches. But if 10 years later that same watch sold for £1,300 then your £20,000 could only have bought you 15 watches. Following Option 2, you would be able to buy 19 watches after 10 years. So even though you got an extra £5,000, you’re still missing out.

So how could you have put your money to better use? Enter Option 3…

Option 3:

You exchanged your £20,000 to dollars and invested this in the S&P 500 (an index of the 500 biggest companies in the USA). Using the same timeline as before, investing your money in December 2007 would have meant investing it just before the markets plummeted in the 2008 recession. This allows us to see what would have happened in a ‘worst-case scenario’. Perhaps surprisingly, your £20,000 would have become £53,500.

That’s a much better result, and to keep our watches analogy, you would have been able to buy 41 watches by 2017. This means investing is the only of our three options that would have beat inflation.

Taking a look below, we can see how many watches we would have been able to buy in each case at the end of 2017:

Past performance is not a reliable indicator of future performance.

Quite clearly, and by a significant margin, Option 3 would have been the most beneficial. However, it would also have been the riskiest.

What do we mean by risk? In finance, this generally means how much the price of an investment goes up or down. Take a look at the chart below:

Portfolio value over a 10-year period from 2007 to 2017. Past performance is not a reliable indicator of future performance.

Because you invested your £20,000 just before the 2008 financial crisis, you would have lost about a third of your invested capital within 14 months, when the markets were at their worst point. However, within 3 years, you would have fully recovered; and by 2017, you would have more than doubled your initial investment.

In contrast, both the current and the savings account remained steady and low risk throughout the same period.

Of course, investing like this can be nerve-wracking. At the time, many people decided to withdraw their investments when prices were falling or at their lowest point. Doing so in our example would have left you about £6,000 worse off in early 2009 and unable to recover, whilst resisting the urge to do so would have reaped much larger benefits down the line.

Look, we’re not saying you should put all of your money in the S&P 500, this would hardly make for a diversified portfolio. However, we do believe it is important to know how you can make financial decisions that will make your money work for you.

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How did we work this out? We made the following assumptions to show you an accurate picture of what would have happened;

1. Our 10 years will start in December 2007 and end in December 2017. Given that we can’t see into the future and don’t want to lead you on pretending that we can, we have used historical data for our example. We have also used this time period as, with all the conflicting chatter around Brexit and a potential recession, it seemed pertinent to show how your money would have performed if you started saving just before the last recession hit and resisted the urge to take your money out of your savings or investments.
2. While current accounts in the U.K. used to pay interest rates, the majority of banks have not done so since the last recession. While we realise that some still do, they usually have strict terms attached to them and so for the purposes of this example, we assumed that money was held in a basic current account. Where we refer to ‘strict terms’ of current accounts these may include a minimum account balance, minimum deposit per month or interest only paid up to a certain amount. This list is not exhaustive and should only be suggestive of the types of terms that may exist.
3. We used annual average savings data. The average easy access (savings account with minimal restrictions on withdrawals) account rate is 0.64% in 2019, which is lower than the average rate of approximately 2.5% over the time period tested.
4. We have used the S&P 500 as an example investment. The S&P 500 is an index of the 500 largest public companies in the USA. An index cannot be invested in directly. The stock market has a higher inherent risk than saving in a current account or savings account, meaning that an investment can go up or down and capital is at risk. All figures are calculated using historical S&P 500 data.
5. Inflation is calculated using historical CPI data for the U.K.

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ikigai is a trading name of Ikigai Invest Services Limited, a company registered in England and Wales (Company number: 12011662). Ikigai Invest Services Limited is registered with the Financial Conduct Authority (FCA) as an EMD Agent (reference number: 902740) of PayrNet Limited, an Electronic Money Institution authorised by the FCA (reference number: 900594) and is an appointed representative of WealthKernel (reference number: 723719) which is authorised and regulated by the FCA. ikigai is not a bank. Registered address: 16 Great Chapel Street, London, England, W1F 8FL.