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 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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The Difference Between Saving and Investing
Before we look at the benefits of saving and investing and examine whether it is better to save or invest, let’s quickly look at the difference between the two.
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.
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.
There are many options available to people wanting to invest their money - such as bonds, stocks, Exchange-Traded Funds (ETFs) and mutual funds.
Unlike savings, investments are not insured and, therefore, any investment runs the risk of total loss. However, the level of risk varies between 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 not always instantaneous and sometimes involves 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.
Risk and return are two of the key differences of investing vs saving. Saving money is low risk, but the potential return is also strictly limited to the current interest rate. On the other hand, investing typically has much higher risk, but with it comes unlimited potential in terms of returns.
Inflationary Risk
We have noted that keeping money in the bank is low risk, but it isn’t completely risk-free.
The risk of keeping money in the bank is that the interest earned on your savings will be outstripped by the rate of inflation, something which has been particularly relevant in recent times.
Inflation represents the decline in purchasing power of a currency over time, caused by rising prices. If the rate of inflation is higher than your bank’s interest rate, then money which is held there is losing its value.
Default and Market Risk
Whilst inflationary risk is also present with investing, the more serious risk is that the value of your investment will fall or even become worthless. However, this risk varies depending on the investment in question.
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 very little risk, provided you intend to hold the bonds until maturity. This is because, although possible, the likelihood of one of these governments 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 ETFs, 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 saving or investing your money it is important to create a risk management plan to help anticipate and, hopefully, minimise the associated risks.
Should I Save or Invest?
It may be clear now that it isn’t really a case of saving or investing, but rather one of saving and investing, as both are important for financial security.
Initially, when considering saving vs investing, saving money should be prioritised. It is important to have readily accessible cash on hand in case anything unforeseen happens. 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 this safety net in place should you begin investing, and you should only ever invest money which you can 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 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.
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Saving and Investing – FAQ
Is it Better to Invest or Save Money?
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.
Should I Save First and Then Invest?
Yes. Before investing, it is sensible to create an emergency fund of cash which is sufficient to sustain yourself through any unforeseen circumstances.
How Much Should I Save and Invest?
There is no real answer to this question, as it will be different for everyone. Before saving or investing, it is a good idea to go through your monthly income and expenditure. Once you know how much you spend each month, you can use this information to make a decision on how much to save. A good starting place might be to save enough money to cover necessities for three months.
Going through your expenditure will also allow you to see how much money you have left over each month which you can spare for investing. Remember, never invest money which you couldn’t live without.
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.
