Jeff Salway: Play the market in savings slump

CAUTIOUS savers are piling into stock market investments as the returns from cash accounts continue to be ravaged by inflation.

The amount of money in UK investment funds has reached a record high, new figures show, a trend reflecting growing confidence in stock markets, fears over bonds and the fact that real returns from cash are all but impossible in the current climate.

Cautious savers helped drive the funds under management by UK unit trusts and open-ended investment companies (OEICs) past the £700 billion mark for the first time in February, the Investment Management Association (IMA) reported last week.

The best-selling sector was the Mixed Investment 20-60 per cent Shares, formerly known as cautious managed funds, pointing to the influx of money from savers drawn to apparently low-risk equity ­investments.

Also popular are UK Equity Income funds, long favoured by those looking for yield-producing alternatives to cash and bonds.

Short-term volatility can be costly, however, deterring those unable or unwilling to risk any prospect of losses from investing in stock market funds.

You’re better off leaving your money in savings accounts if the prospect of any losses would give you sleepless nights, said Patrick Connolly, certified financial planner at AWD Chase de Vere.

“The most cautious investors should remain in cash, focusing on achieving competitive rates of interest and paying as little tax as possible, while accepting that the value of their savings may continue to fall in real terms,” he said.

“However, other investors should look at alternatives to generate better growth.”

Returns from equities comfortably outstrip those from cash accounts over the long term. When held for five years, equities have since 1901 outperformed savings accounts for 74 per cent of the time. That rises to 90 per cent of the time when they have been held for 10 years, according to the Barclays Equity Gilt study 2012.

So how can you avoid taking too much risk when you’re dipping a toe into markets for the first time?

First check that you have enough cash available to cover your short-term needs.

“Before considering investing in the stock market, you should make sure you have paid off any debts where you are being charged a high rate of interest and you have enough money in cash to cater for any short-term emergencies or requirements,” said Connolly.

There are other steps you can take to mitigate risk and get the best out of market-based investments. Here are a few to consider:

Diversify

By spreading your investments across different (preferably non-correlating) assets and funds you can ensure you don’t have all your eggs in one basket.

“Having too much money in one asset class or sector that under-performs will have a significant negative effect on your overall Isa portfolio,” said Connolly.

“Spread your money across different assets such as equities, fixed interest and commercial property, but make sure this is in the right proportions to meet your objectives and attitude to risk.”

Drip-feeding works

Regularly investing modest sums (£25 or £50 a month, say) makes investing more affordable and allows you to gain from pound-cost averaging. This is where your money buys units at different times rather than at one price, meaning you buy more when prices are low and benefit when they rise.

It’s also a more sensible way of dipping your toe in the water than investing hundreds or thousands of pounds at once.

Keep your eyes on the horizon

Stock market-based investing is ideally for the long haul – at least five years – so that any short-term volatility can be smoothed out over time.

Selling out when things are rocky is the worst thing you can do, leaving you with losses and no chance of recovering lost ground.

Alan Steel, chairman of Alan Steel Asset Management, points to US research highlighting the dangers of bad ­decisions.

“The most recent Dalbar Annual Survey shows that the average equity investor in the US under-performs the S&P 500 index by more than 4 per cent a year, thanks to poor buying and selling,” he said. “That’s 55 per cent less profit.”

Take the multi-asset approach

This involves investing either in a range of funds across different assets and sectors, or in individual multi-asset funds offering that diversification under one roof.

The latter can be ideal for savers taking their initial plunge into equities or for those without sufficient money to invest in a wide range of individual funds.

Connolly likes the Cazenove Multi-Manager Diversity, which invests in equities, cash, fixed interest and alternative investments.

Steel recommended the Darwin multi-asset fund run by David Jane, for investors “who don’t care about income but want to feel safe in bad times and are happy with decent gains in good times”.

He added: “David Jane runs this fund the way his mum likes – no nasty surprises – and it’s up over 13 per cent over the last 12 months.”

Let the manager do the work

Multi-manager funds can be either “fund of funds” or “manager of managers”.

The former are the most common, investing in a range of funds that are already available. The latter use different managers to run different parts of the portfolio.

Tom Munro, owner of Tom Munro Financial Solutions in Larbert, picked out the 7IM Moderately Cautious Portfolio as an example of a multi-manager­ fund for investors new to equities.

“It usually contains a minimum of 35 underlying ­holdings at any one time and, more importantly, the portfolio is re-aligned automatically each quarter to reflect economic conditions,” Munro ­explained.

Go for income

Funds that produce income may seem a logical proxy for cash accounts, but the best results come from reinvesting that income. Someone who invested £100 in UK shares in 1945 would now have just over £7,400 to show for it. But with all the dividends reinvested, the £100 would have grown to more than £130,000, the Barclays Equity Gilt study shows. Steel said investors should gain confidence from the returns produced by leading income managers such as Neil Woodford, who runs the Invesco Perpetual High Income fund.“For those seeking international exposure I’d also have a look at the Newton Global Higher Income fund managed by James Harries,” Steel added.

Twitter: @vaughansalway