Key takeaways
Investing in a diversified mix of equities and bonds can help to preserve and grow wealth. Staying invested over time can benefit from the compounding of returns and result in better outcomes than attempting to time the market.
- The value of cash can be eroded by inflation: rising prices mean the same amount of cash may buy fewer goods and services over time.
- Getting invested may help to preserve and grow wealth: exposure to assets that may grow at a higher rate than inflation can help to preserve purchasing power and build wealth.
- Diversifying across asset classes can be beneficial: investing across a mix of assets can help to diversify sources of risk and return and allow customization of a portfolio to the investor’s individual goals and requirements.
- Time in the market, not timing the market: attempting to time the market is difficult and may prove costly. Staying invested can allow wealth to compound over time, with longer holding periods historically being more likely to generate positive returns.
What is meant by 'investing'?
Saving refers to the practice of putting cash aside, often in a relatively safe, but lower yielding, money-market account, in order to preserve wealth. Investing, by contrast, seeks to preserve and grow the purchasing power of wealth over time, through owning assets with exposure to economic growth, such as equities and bonds. By investing in a way aligned with their individual risk tolerance and liquidity needs, investors can make cash work harder to help meet their goals.
Cash can lose value over time
Cash is an important source of liquidity, and some cash is necessary to hold. However, as a low-risk asset the returns from cash when held on deposit or in a money market fund are relatively low and they may struggle to keep up with inflation, as shown below.
Inflation is the tendency for the prices of goods and services to rise over time. It reduces the quantity of goods and services that can be bought with the same amount of cash. For wealth to grow in terms of after-inflation purchasing power, it must increase in value at a faster rate than inflation.
Combatting inflation through investing
Investing in assets linked to economic growth and corporate profits, such as equities and bonds, may allow wealth to grow over time at a faster rate than inflation.1 Through a combination of capital appreciation as asset prices rise, and income from dividends or received interest coupons, investments have the potential to grow over time. Where income received from investments is reinvested, investors may also benefit from compounding, i.e. returns on this reinvested income.
Diversifying across investments
Different investments have different risks and potential rewards. Cash is a very safe asset but typically comes with low returns from holding it. Bonds offer higher returns than cash but are subject to credit risk. Equities have historically offered higher returns still, but they also come with the most risk of the three asset classes, being more directly tied to company performance. When investing, it can be helpful to diversify across asset classes and hold a mix of equities and bonds. Taking exposure to assets with a range of different risk and return drivers may help to smooth portfolio-level returns. It can also be beneficial to diversify within asset classes, for example by investing across different geographic regions and economic sectors. Being invested will not look the same for every investor. The right asset allocation will depend on each investor’s individual time horizon, risk tolerance and financial goals.
Staying invested over time
Once invested, it’s important to stay that way. Fluctuations in asset prices may make attempting to time the market seem attractive — for example by attempting to exit and re-enter investments at relatively high and low levels (respectively) in the hope of securing a profit — but in practice this is hard to do and may be costly.
Trying to time the market can hinder long-term investment performance as it creates the possibility of being uninvested when the market delivers strong positive returns — the best days in markets often occur close to the worst.
The chart below shows the impact of missing out on being invested in global equities through a small number of high-performance days historically.
Staying invested can allow investors to ride out short-term fluctuations in prices and avoid the potential pitfalls associated with attempting to predict asset prices. Historically, longer investment periods were also more likely to generate positive returns.