Should I Save or Invest?
Save or invest? This is a question which we will all face at some point in our lives. Although some people may think the difference of saving vs investing is fairly trivial, the truth is that they are two very distinct concepts, each with their own purpose. In this article, we will take a look at the difference between saving and investing and explain why both are important.
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What Is the Difference Between Saving and Investing?
Before we examine whether or not it is better to save or invest, let’s take a look at the difference between saving and investing, as well as some of their associated advantages and disadvantages.
Saving
Saving involves placing money aside, usually with a bank, in either a savings or current account. People may be saving the money towards a specific purpose - such as a deposit on a house - or just putting the money away for the future.
One of the main advantages of saving money is that money held in a bank tends to be very liquid. In other words, when savers need to access their money, they can readily do so without delay.
Some countries also offer a degree of protection to savers who store their money in a bank. For example, in the UK, bank deposits are insured up to £85,000 under the Financial Services Compensation Scheme.
Investing
Investing also involves putting money aside for the future. However, the primary purpose of investing is to use money to create more money. There are many options available to people who want to invest their money - such as bonds, stocks, Exchange-Traded Funds (ETFs) and mutual funds.
One of the disadvantages of investing is the associated risk which accompanies it, which we will look at in more detail shortly. Unlike savings, investing is inherently risky, with total loss being a possibility with any investment. However, one of the biggest advantages of investing, is that this higher risk is accompanied by higher potential rewards.
Saving vs Investing: The Risks
We touched on this in the previous section, but a key difference between saving and investing is the risk and reward associated with each activity.
When it comes to saving vs investing, saving money is certainly lower risk. But any return on savings is limited to your bank's rate of interest. On the other hand, investing typically has far higher risk, but the potential returns are considerably higher.
Risks of Saving
Saving money in the bank may be low risk but it is not completely risk free.
Perhaps the most obvious risk of saving is the possibility of the bank going bust. However, as mentioned, many developed economies offer savers a certain degree of protection from this possibility.
Something else which savers will need to consider is the inflationary risk which comes with saving money. Inflation represents the decline in money’s purchasing power over time, caused by rising prices.
If the rate of inflation is higher than your bank’s interest rate, then money sitting in the bank is effectively losing value over time.
Risks of Investing
Inflationary risk is also present with investing, however, the more serious risk is that the value of your investment will fall or even become worthless. The level of this risk varies depending on the investment in question.
Investing in high quality bonds, for example, is generally seen as low risk. This is particularly true if the bonds are issued by a government such as the UK or the US, as the possibility of one of these nations defaulting on its sovereign debt is very low.
However, that doesn’t mean that bonds are without risk. Defaults can and do happen. There are even many examples of governments defaulting on their national debt in times of crisis.
With investments in the stock market, there is the risk of the market not moving in the desired direction and, as a result, the loss of capital. Generally, the stock market is seen as riskier than the bond market but the actual level of risk comes down to individual companies.
Should I Save or Invest?
As we have seen, whether you're investing or saving, there are risks involved as well as different advantages associated with each. So, should you invest or save? The reality is that both are important for financial security,
Initially, when considering saving vs investing, saving money should be prioritised. It can be important to have readily accessible cash on hand in case anything unforeseen should happen.
Only once you have this safety net in place should you start thinking about investing and you should only invest money which you can afford to live without for the foreseeable future.
Investing is intended to create wealth over the long-term and should consequently be used to achieve financial goals which are more than 5-10 years away, such as retirement.
This means that you should not invest money which you are going to need in the short-term. This is primarily because of the volatile nature of the financial markets. Short-term price fluctuations could significantly impact the value of your investment, whereas these fluctuations tend to smooth themselves out over the long-term.
How Much to Save vs Invest
So, when should you invest instead of save? There is no set rule as to how much money you should keep in savings.
The answer may be different for different people depending on their specific circumstances. When considering this question, it is a good idea to calculate your monthly outgoings and then set yourself a goal of saving enough money to cover these outgoings for a number of months.
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FAQ
Is it better to have savings or invest?
Saving and investing are both important tools for securing your financial future. Ideally, if possible, people should do both, creating enough savings to cover unforeseen circumstances and then investing regularly for the future.
How much money should I save before I invest?
There is no definitive answer to this question. However, a good place to start might be to ensure you have sufficient savings to cover necessities for at least three months.
At what age should we start investing?
When it comes to investing, it’s usually a case of the earlier the better! The earlier you start investing, the more opportunity you give your investments time to grow.
Should I pay off debt before investing?
If you have any high interest debt outstanding, such as unsettled credit card bills, it is prudent to pay this off before you start investing. Simply put, it is unlikely you will find an investment which will reliably produce a higher rate of return than the interest rate of a credit card. Consequently, you would likely end up losing money.
About Admirals
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
