With markets constantly fluctuating, it can be difficult to figure out the best choice for your savings and investments. Your reflex may be to park your money in cash savings, but there may be another way to yield more in the long run.
Depending on your goal, cash sitting in a bank account or cash investments can be a great choice. Yet, for building wealth over a longer stretch, there might be better choices. While cash can shield you from immediate risk and volatility, here are three reasons why different types of investments or asset classes (including equities) can be the better choice for the long haul.
1. With time, inflation can erode your purchasing power
Even if the dollar value of your savings stays the same, your purchasing power weakens as the goods and services you buy become more expensive over time due to inflation. In other words, as the years tick by, the same sum buys less and less.
The further you look into the future, the more important it is for your savings to grow faster than inflation. Consider this: A 2-per-cent inflation rate (which is the midpoint of the Bank of Canada Opens in a new window. target rate) will turn $1.00 today into $0.82 in 10 years, $0.67 in 20 years and $0.55 in 30 years.
Investing in equities as part of your investment portfolio can help balance this impact. After accounting for inflation, the average annual return on Canadian stock investments has averaged 5.6 per cent a year since 1900 Opens in a new window..
2. Cash savings may come with a higher tax bill
Compared to cash sitting in a taxable account, equities are a much more tax-efficient way to build wealth and save for long-term goals, such as retirement. Capital gains and dividends get favourable tax treatment in non-registered accounts, so the advantages can add up over time.
3. Your greatest asset is time
If you're earning flat or negative returns with cash, you miss out on the benefit of compounding returns Opens in a new window., which become more pronounced with time.
Take a $1,000 investment. Assuming a 5-per-cent annual return, that'll turn into $1,050 after one year. If you continue to invest that return, the lump sum gets bigger year after year. That phenomenon — earnings growing without adding to the principal — is compounding in action.
The snowball effect is growing that initial investment by hundreds of dollars in just a few short years.
If this example shows us anything, it's how important it is to make sure you're earning a healthy return on your money to maximize long-term earnings.
Your best option? As part of a balanced portfolio, include equities with other long-term investments.
In the long run, compared to cash investments, equities may offer stronger potential returns that outpace inflation and provide better tax benefits in non-registered accounts.
And while most of us would rather think about potential gains than missed opportunities, the reality is that by developing a diversified portfolio, you may help to minimize your risk over time— and maximize returns for you and your family.