Even though many UK shares have moved higher in price in recent months, there seems to be scope for a stock market rally over the long run.
Indeed, the UK stock market continues to trade lower than it did prior to the coronavirus pandemic. With economic growth set to return and major monetary policy stimulus prompting improving investor sentiment, the long-term outlook for stocks seems to be attractive.
As such, now could be the right time to avoid relying on cash to build a retirement nest egg in favour of investing money in undervalued UK shares.
The likelihood of a stock market rally
Of course, there is no guarantee that a stock market rally will take place in the coming years. The coronavirus pandemic is an extremely rare event that has left all investors unable to accurately predict the course for the global economy over the coming months.
However, history suggests that the stock market recovers well from even its very worst challenges. For example, bear markets such as the 1987 crash and the global financial crisis caused severe challenges for investors in the following months and years. However, the stock market recovered on both occasions, and has been able to deliver high-single-digit returns over recent decades.
Therefore, investors who have a long time horizon are likely to benefit from a stock market rally. Through buying and holding high-quality companies, it is possible to obtain significantly higher returns than are available from other mainstream assets. In doing so, an investor can benefit from the effect of compounding. This could turn a modest investment into a large nest egg over the long run.
Avoiding large sums of cash in favour of UK shares
Of course, holding some cash in case of emergency is always a sound move. Even if there is a stock market rally in the next decade, an investor needs to retain a degree of liquidity. Otherwise, they may be unable to remain solvent should their financial situation change. For example, their employment position may change. They may require access to cash in the short term to cover a temporary reduction in earnings.
Therefore, holding some cash is a prudent step to take. However, relying on savings accounts to build a retirement nest egg is unlikely to provide financial freedom in older age. The return on cash has generally been substantially lower than that of UK shares. In the coming years, the difference between the two assets may be even greater due to persistently low interest rates.
As such, now could be the right time to start building a portfolio of UK stocks ahead of a likely stock market rally. Doing so could have a positive impact on an investor’s retirement plans, and may even allow them to retire early.