Over the last 20 years or so I have met with hundreds of potential new clients and a reasonable proportion say that they are very cautious by nature when it comes to investing. This can mean that they spend decades with much more money than they need to have in the bank, building society and other ‘secure’ assets. We all need a cash contingency fund for emergencies and imminent expenditure but let us use the example of £100,000 that isn’t expected to be required for a good few years. The attraction of cash deposits to a ‘cautious’ investor is that, in 12 months’
This may not feel like a major issue after one year, but it is much more serious over, say, 20 years.
time, an interest rate of 2% would mean that the investor has £102,000, i.e. a guarantee that they will have more money than they started with. However, if inflation (i.e. the increase in prices) was 3% over the same 12 month period and the interest rate was 2%, there has been a net loss of 1% in purchasing power, i.e. £102,000 can buy less in the shops than £100,000 could have bought 12 months earlier. This may not feel like a major issue after one year, but it is much more serious over, say, 20 years. Assuming identical interest and inflation rates, after 20 years the purchasing power of the original £100,000 would have reduced to £82,000. Compare this to invested money returning, for instance, 2% per annum above inflation. In this case, your purchasing power would have increased from £100,000 to £148,000 over the same 20 year period. This is a massive difference. The trade-off is that the value of the investments will fluctuate over time and will not grow in a straight line. This is where many investors confuse volatility (temporary ups and downs) with risk.
All downturns will be temporary. The financial press love to say that ‘this time it’s different’ but the overwhelming balance of probability is that it won’t be. The risk isn’t whether investments will rise and fall over shorter time periods (they will – they always have done, and they always will do). The risk is the ‘reckless caution’ of keeping long-term money in an environment that is likely to result in the loss of purchasing power over time.
