Saving vs Investing: Should I Save or Invest My Money?
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 between the two is fairly trivial, the truth is that they are two very distinct concepts, each with their own purpose.
In this article, we will analyse the differences between saving and investing and explain why, it is not necessarily a question of which is better, but more a question of finding the right balance in your portfolio of saving vs investing.
What Is 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.
Money placed in savings is readily accessible to savers when they need it, in other words, it is very liquid. If held in a UK bank, the money is also insured under the Financial Services Compensation Scheme - meaning that if your bank goes bust, you would be returned the first £85,000 of your savings.
What Is Investing?
Investing also involves putting money aside for the future, however, the primary purpose of investing is to use your money to create more money and make yourself wealthier. This is done through the purchase of assets, which an investor believes will either grow in value over time or generate income.
Unlike savings, money placed in investments is not insured and, therefore, any investment runs the risk of total loss. However, the level of risk varies between the different financial instruments - for example, purchasing bonds from the UK government, also known as gilts, carries far less risk than purchasing shares in a start-up company.
Moreover, invested capital is far less liquid than capital which is in a bank. Unlike a bank, where one can generally withdraw money at will, liquidating an investment is usually more cumbersome, sometimes involving finding a counterparty willing to buy your asset.
The Risks of Saving vs Investing
We have now explained what saving and investing both are and, in doing so, have highlighted some similarities and a couple of the key differences between saving vs investing, including the concept of risk, which we will develop further here.
Risk and return are two of the key differences between saving and investing. Saving money is low risk, but the potential return is also strictly limited to the current interest rate. On the other hand, investing can carry a much higher risk, but with it comes unlimited potential in terms of returns.
We have noted that money held in a UK bank is insured up to £85,000 - making this a safe destination for your cash. However, that is not to say that holding money in a bank is completely without risk.
Since 2008, interest rates have been kept at record lows by the Bank of England and they show no immediate signs of rising. Therefore, the very real risk of keeping money in the bank is that the interest earned on your savings will be outstripped by the rate of inflation.
Inflation represents the decline in purchasing power of a currency over time, caused by rising prices in an economy. If the rate of inflation is higher than the interest rate, then, over time, money which is being held in a savings account loses its purchasing power.
Default and Market Risk
Whilst inflationary risk is also present with investing, the more serious risk is that your investment will fall in price or even become worthless. As mentioned above, this risk varies depending on which instrument you choose to place your money in.
When you purchase bonds, you are in essence lending money to the bond issuer to be repaid at maturity plus any interest in the interim and, therefore, there is a risk of default.
Investing in bonds from a government such as the UK or the US carries little risk, provided you intend to hold the bonds until maturity. This is because, although possible, the likelihood of a government such as the UK defaulting on its sovereign debt is incredibly low.
This is not to say that all government bonds are a safe investment, it depends on the government issuing the bond. For example, since 1827, Argentina has defaulted on their national debt on nine occasions, a global record.
With investments such as stocks and funds, there is the risk of the market not moving in the desired direction and, as a result, the loss of capital.
All this is to say that, wherever you keep your money, it is always at some kind of risk. Before investing your money it is important to create a risk management plan to help anticipate and, hopefully, minimise the associated risks.
Saving vs Investing
Initially, when considering saving vs investing, saving money should be prioritised. Even the most ardent advocate of investing would most likely stress the importance of having readily available savings on hand in case anything unforeseen occurs.
There is no rule when it comes to how much money you should keep in savings, however, having enough to cover your necessities for at least three months is a good place to start.
Only once you have these safeguards in place should you begin investing and you should never invest money which you could not afford to live without.
Investing is intended to create wealth over the long-term, which means that you should not invest money which you are going to need back in the short-term. The reasoning behind this is two-fold.
Firstly, as we noted earlier, money placed in investments tends to be less liquid than money placed in a savings account, meaning that your money is not readily available as and when you need it.
Secondly, and perhaps more importantly, the volatile nature of the financial markets means that you may not see a significant, or any, benefit from investing over the short-term. Short-term price fluctuations could significantly impact the value of your investment, whereas these fluctuations tend to smooth themselves out over the long-term. Moreover, entering and exiting positions in the financial market tends to incur fees from your brokerage and capital gains tax from the government - both of which would further reduce any potential short-term profit.
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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.