When it comes to talking about putting your money to work, terms like ‘investing’ and ‘saving’ are often used interchangeably. They shouldn’t be. There are key differences between the two that are worth understanding as you strive to meet your long-term financial goals.
Ever had an older relative tell you it’s time to ‘start saving for retirement’? What about someone who’s advised you to ‘invest with the future in mind’?
It’s easy to lump these two pieces of advice together. After all, both involve setting aside some cash today for something that occurs years – or even decades – from now.
Investing and saving, however, aren’t the same thing. It’s important to know the difference so that you can understand what kind of returns you can expect on the money you’re putting to work and when you’ll be able to access it again.
Let’s start with a few definitions…
"Generally speaking, the more risk you take on, the more return you should expect to generate from your investment if everything goes to plan."
In simple terms, investing involves the purchasing of an asset in the hope that it will grow in value. If an asset becomes more valuable, it can then be sold for a higher price than it was purchased, earning you a profit (or return).
People commonly talk about investing in the stock market – i.e., buying shares of companies in the hope that the price of these rises. There are lots of assets (or types of investments) people can purchase, however. Property, for example, is a common and popular investment many will encounter in their lives if they aspire to become homeowners. You may also acquire art, memorabilia or even fine wine throughout your life. All of these can be investments if your intention is to sell them at a later stage for a higher price than you bought them for.
Investing involves risk. There is always the possibility that what you’ve bought may fall in value. The stock price of a company may decline after poor financial results. Your home could be less desirable if it’s located in a newly established flood zone. You could struggle to find a buyer for the signed David Beckham football boots you bought a few years ago.
Generally speaking, the more risk you take on, the more return you should expect to generate from your investment if everything goes to plan. Which brings us nicely on to…
"If you’re saving money – rather than investing it – one reason could be because you may need it quickly."
In contrast to investing, when you save money, it’s generally put in savings accounts that pay minimal rates of interest. The money you put aside in this way won’t grow much on its own – the low interest rate means returns will be limited. It will, however, generally be safe and won’t be lost in the event markets take a downwards turn.
If you’re saving money – rather than investing it – one reason could be because you may need it quickly.
Let’s say, for example, you had £1,000. You used half of it to buy shares of FTSE 100 companies and put the rest in a savings account.
After a year, your car unfortunately breaks down. And it’s doubly bad – the market has also fallen 10%.
That means the £500 you bought shares with is now £450. If you were to sell these now to pay for your car repairs, you’d be ‘locking in’ a loss of £50. And if the market subsequently rose 20% in a future period, you’d miss out the opportunity to make your money back.
The £500 you put in savings, however, won’t have lost any value – at least in absolute terms. You could use this money to meet your unexpected costs, leaving your investment alone so that it can ‘ride out’ the down market and make its value back.
"Investments like stocks have the potential to return much higher amounts. Historically, stock markets have risen over the long term."
You’re extremely unlikely to lose money by putting it in a savings account, but this doesn’t mean it won’t lose value. Many such accounts pay interest below the rate of inflation. If you only earn 0.5% interest on your money while inflation is at 2%, your purchasing power will be reduced.
Investments like stocks, on the other hand, have the potential to return much higher amounts. Historically, stock markets have risen over the long term. The FTSE 100, for example, has returned an average of 7.5% annually since its inception in the 1980s. The S&P 500 has seen long-term average annual returns between 8% and 10%.
Such returns can help meet long-term financial goals – say if you want to buy a house or go on a dream trip five years from now.
Past performance, however, isn’t an indicator of future results. While stocks have generally offered attractive returns, this is by no means guaranteed. There is always the possibility in any given year the market will lose money. That’s why it’s important that, if you invest in stocks, you recognise the need to hold them for the long term to allow for fluctuations in performance.
Think about when you need the money you’re putting aside and why you’re doing so. Is it possible you’ll have a big expense due in six months or a year? If so, it may be worth opting to put money in a place where it wouldn’t be impacted by shorter-term market moves.
Whether you’re saving or investing, it’s good to have a plan. Establishing your budget, appetite for taking risks and what you’re putting money aside for can help with identifying the best place to put your cash.
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