Had Warren Buffett invested his capital in savings accounts, he would not have become one of the wealthiest people on earth. Instead of generating a market-beating return over a sustained period of time, his capital would most likely have delivered a negative real-terms return. As a result, his spending power would have declined, rather than risen.
As such, following Buffett’s lead and investing in the stock market instead of holding cash could be a good idea. As there are numerous companies that appear to be undervalued at the present time, now could be the right time to buy stocks. It could improve your retirement prospects and boost your passive income in older age.
Negative returns
Cash ISAs may offer no risk of loss, but when inflation is factored in, they currently produce a negative return. For example, the best Cash ISA rates are around 1.5% at the present time. With inflation expected to remain above 2% throughout 2020, an investment in a Cash ISA is likely to be able to purchase fewer goods and services in a year’s time than it is today. Money in a Cash ISA may be ‘safe’ but that strikes me as madness.
Over time, negative real-terms return could become increasingly destructive to your retirement prospects. Therefore, even though having some cash on hand at all times is a good idea in case of emergency, relying on a Cash ISA to build a retirement portfolio is unlikely to be a worthwhile move.
High growth potential
By contrast, buying undervalued shares as Warren Buffett has done during his career could be a highly profitable idea. Certainly, not all investors will be able to achieve his level of outperformance of the index over a long period. But even achieving a similar return to the wider stock market, such as the FTSE 100’s historic return of 8% per annum, could lead to significantly higher returns than are available through holding cash.
Of course, the stock market’s current price level suggests that its returns could be highly appealing in the long run. The FTSE 100, for example, yields 4.5% at the present time. This is above its long-term average, and indicates that investors are pricing in a wide margin of safety. Although this may be valid in the short run due to the risks faced by the world economy, over the long run, the index’s yield suggests that it could offer a favourable investment opportunity.
Risk/reward
For some savers, the idea of losing money in the stock market makes it highly unattractive. However, by diversifying among a wide range of shares and adopting a long-term outlook, it may be possible to overcome many of the risks associated with buying shares.
Furthermore, from a risk/reward standpoint the stock market’s return potential could make its relative uncertainty compared to a Cash ISA worthwhile for many people – especially those who are seeking to build a retirement nest egg to retire early. Â