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Nov 17

How you can beat savings accounts with index-tracking funds

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Even the highest-paying savings accounts struggle to keep up with inflation. Tucking your spare cash away into a cash savings account can actually DECREASE your buying power as interest rates continue to stay low against inflation. Index-tracking funds could be a way to beat inflation.

Index-trackers are a form of investment. That means there is some risk to investing your money – you might lose some or all of your investment. However, index-tracking funds offer an easy and cheap way to enter the stock market and see returns that beat the rate of inflation.

If you’ve got spare capital to invest – other than your emergency easy-access cash buffer fund that everyone needs – consider index-tracking funds. This guide explains everything you need to know – including how to invest.

 

Bank savings account v index-tracking fund

Everyone needs an instant-access cash fund for emergencies. However, when you’ve got that fund saved – what do you do with your surplus savings?

If you have capital to invest for the mid- to long-term, at least five years, you’re going to see better returns with index-tracking funds than a cash savings account.

Yes, there may be times that your returns dip or you could even lose some of your investment. That’s the risk versus reward element of investing in stocks and shares. However, when you invest for the longer term, the highs and lows average out – which is why you’ll need to tie up your money for at least five years. It’ll be worth it!

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.
  • The stock market is unpredictable so you’re taking a risk investing in it. However, this means that potentially you could get a greater reward.

(You could lose 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 from 1899 – 2015:

  • Cash 0.8%
  • Gilts 1.3%
  • Shares 5%

When you look closer at the years 2005 – 2015, this gets more shocking:

  • Cash -1.1%
  • Gilts 3%
  • Shares 2.3%

Even though returns from shares were lower in this period than overall, they still beat cash – which had NEGATIVE returns!

The other thing to remember is that what goes down, must come up. When historical stock market crashes have occurred, they’re soon followed by what’s called a ‘bear run’. That means the market rockets again as people take advantage of lower share costs.

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How do tracker funds work?

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.

When you invest in a managed fund, you could face fees around 0.85% – but the average tracker fund costs 0.1% in fees. It doesn’t sound like a huge difference, but it really is in the long-term! Of course, a managed fund is more expensive because you’re paying for fund managers to actively move money around to mitigate perceived risks. Tracker funds don’t move money around like this, which is why they’re much cheaper.

Tracker funds ‘track’ a particular stock market index (i.e. defined group of companies such as the FTSE 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.

How to invest in index-tracking funds

Online broker platforms makes it easier than ever to invest in the stock market. You don’t always need to hire a stockbroker to make transactions for you!

Platforms such as eToro and Interactive Investor make it easy to invest in funds on the stock market. Sign up, choose your funds, and invest. It’s really that simple!

Other platforms and providers to try include:

These platforms also let you invest through a stocks and shares ISA platform. We LOVE these at Moneymagpie, and strongly believe they’re MUCH better than a cash ISA account. Equities ISAs are easy to invest in as you can choose a ‘wrapper’ that comes with a pre-selected investment that suits your risk appetite (how much risk you’re willing to take). Investing through an ISA product also provides additional tax benefits.

Alternative investment

If the idea of investing in the stock market STILL gives you chills, consider other investments.

For example, peer-to-peer lending also carries some risk BUT could be a way to receive steady returns of 3, 5, or even 7%. Platforms such as Zopa and Ratesetter make it easy for you to offer your money as a loan to those who need it. It’s a win-win situation: people who may not get a typical bank loan can access finance at a lower rate than the high street, while you get a return on your investment.

Remember, too, that your pension – the ultimate long-term savings pot – offers great tax advantages. If you want to find out more about investing in your retirement, check out our article about Self-Invested Personal Pensions and download our free retirement guide.

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 $81 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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