MoneyMagpie

Sep 28

How you can beat savings accounts with index-tracking funds

Best savings accounts just aren’t cutting it in today’s low-interest-rate times. In fact, savings accounts have never performed as well as long-term investments. Here’s why you should use the bad returns on cash you’re getting now to move your investment money to index-trackers.

Are you sick of getting almost nothing on your savings? Aren’t you tired of being pretty much punished for doing the right thing and saving? It’s not your fault that interest rates are so low, and yet it’s hard to know where to put your cash.

Well, if you’re looking to invest for the long-term (i.e. more than five years) then the best place to put your money has traditionally been the stock market. And there’s a nice easy, low-cost way to do it. You put it in an index-tracking fund.

Bank savings account v index-tracking fund

Seriously, if you’re willing and able to tie up your money for more than five years – in other words, if you want to actually invest for the future, not just save a bit for a rainy day – there’s no contest. Shares do best. Over time, the returns you get on shares trounce the returns you get on savings accounts.

And the easiest and cheapest way to invest in shares is through an index-tracking fund.

Why tracker funds?

Tracker funds, or index-tracking funds as they are properly called, are cheap, effective, easy ways to invest in the stock market. They are run by computer programmes and, therefore, only charge a small amount each year to manage your money.

Tracker funds ‘track’ a particular stock market index (i.e. defined group of companies such as the largest 100) by investing some of your money in every single company in that index. This means that as the index goes up or down (depending on how the shares of each of the companies in the index do each day), your investment goes up and down with it.

It’s very simple to invest in an index-tracking fund. The one we like best (and Jasmine has invested in it a few times) is the Legal & General tracker fund. They are one of the biggest providers of index-tracking investments in the UK.  Also, they’re one of the very few financial companies who actively promote tracker funds. It’s easy to get tracker funds in an ISA too because they offer their funds pre-wrapped in an ISA.
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How come shares do better?

It’s largely to do with what is known as ‘risk and reward’. This means that the amount of money you make (the ‘reward’) depends on the amount of risk you’re prepared to take.

  • With savings accounts, particularly those offered by big high street banks, you’re not taking much risk. Therefore you don’t get much reward in the interest rate you’re offered.
  • With the stock market you never really know what it’s going to do so you are taking more of a risk. However, this means that potentially you could get a greater reward. You could lose a lot of money too, although generally, with index-tracking funds, the longer you keep your money in them, the less risky they are.

If you go back 100 years you find that the average annual returns (the money you make on your investments) are low for cash but decent for the stock market.

Here are the average returns (per year) for the three asset classes Cash, Bonds and Shares over the last 100 years:

Cash                               4%

Bonds                            7%

Shares                         10%

So you see the point? Sure, the stock market crashes pretty regularly. Over the last 10 years it’s had a pretty bad run. But that has only happened three other times in its history and each time the market has rocketed up after that ‘bear’ run as they call it.

Alternative investment

If you still can’t bear the idea of putting your money in anything other than savings, at least look at alternatives to the usual, poor-performing bank savings. If you’re willing to tie-up your money for at least a year then you will get much better rates with ‘social lending sites’.

These are sites where you lend your money to people who want to borrow it. So you become a mini bank, deciding yourself what kind of people you want to lend to and, importantly, what rate you want to get for your money. The best one to try is Zopa.

The way it works is that you look at the kinds of borrowers that are around, decide how long you want to lend your money for and what rate you want (the higher the better, of course, but if you go for a really high rate it could take a while for your money to be lent out).

On average, Zopa lenders get about 8.1% on their savings. A LOT better than even the best bank or building society rates. It’s pretty easy to become a lender to as you can see in our article about being a Zopa lender.

To start lending with Zopa and making good money go to their landing page here.

What the experts say

Even if you don’t believe us when we say that index-tracking funds are better than savings accounts for long-term investing, at least listen to what the top guys say. For example, the richest man in the world, Warren Buffett (currently worth $47 billion), who made his fortune through investing, said in 2008:

“Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value… Equities will almost certainly outperform cash over the next decade, probably by a substantial degree.”

Two years after he said that the Dow Jones (the US stock market)  went up 20% and the FTSE went up to nearly 30%. Cash, on the other hand, has been utterly depressing and is likely to continue to be for a while. We know where we’re putting our investments!

 

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