Saving vs Investing: Understanding the Difference

Whilst everybody leads different lives and we all exist in very different circumstances, the majority of people have the same overall aim of building wealth over their lifetime. Within that there can be very contrasting ambitions however.

Ultimately, money gives you security and whether you are saving money or investing money, if either of these are successful then you will feel secure. But when assessing whether saving money or investing money is for you, the key consideration is what your short and long term goals are.

Are you wanting to keep your money safe and available, or are you looking to make money to use in later years?

An important factor in the debate over whether saving or investing is right for you, is cash. Cash in this instance doesn’t mean notes and coins physically in your hands. It means available money.

Liquidity, ie. how ‘liquid’ your money is, means how easy is it to access and use. The word ‘liquidity’ appears as a running theme when considering saving or investing because it dictates so many of your ambitions and how you need to manage your money.

Ultimately, when assessing savings over investing, or vice versa, you need to ask yourself what do I need my money for and when do I need it? Liquidity is what controls this, and as we look at saving and investing in more detail, liquidity is the key consideration.

Savings are generally considered to be a short term option, with the idea of keeping your money safe, but accessible. In this sense, the word ‘cash’ is important.

With savings you are maintaining your money in the form of ‘cash’, ie. it is safe, but it is close to you, you know how much is there and you can access it and withdraw it pretty much whenever you want.

This means that we are keeping our cash as a liquid asset, in that it is safe and secure, but we can spend it if we need to.

What is the purpose of saving?

Essentially, when we are saving money we are accumulating quantities of money with a goal in mind, and when we reach that goal we expect to receive the same amount of money we put in, plus an amount of interest which is usually quite low.

However, we are satisfied beforehand that this outcome is guaranteed.

Your savings goal could be a deposit for a house, a holiday or a home improvement project such as a new kitchen or decking in the garden. Equally, the goal could be open-ended, and you just want to keep money to one side for emergencies.

There is nothing wrong with this, but you should keep in mind that if your goal becomes a long term one, it may make more sense to invest the money and achieve more of a return. If you find that you are merely saving money when you should be investing, you have potentially missed out on a lot of income.

How to save money

Savings accounts

Traditional deposit accounts offer very low interest rates and are really for day-to-day cash usage. Specific savings accounts are a better place to ring-fence money for a specific purpose as they offer a slightly higher interest rate.

There are savings accounts available where you have to commit to depositing a regular minimum amount per month and/or you need to abide by a notice period in order to access your money, in these cases, the accounts would normally offer a slightly better interest rate.

ISAs

These are similar to savings accounts in that you can deposit and withdraw cash as you need to (although there is an upper limit as to how much you can deposit in one tax year) but the key difference is that the interest you earn is tax-free.

There are several different ISA products available aimed at different demographics, such as children, regular savers and people saving for a house deposit, for example.

Fixed rate bonds

A fixed rate bond is a type of savings account where you deposit a lump sum for a fixed period (usually from six months to five years) and enjoy a higher interest rate than a regular savings account.

However, you can’t access the money until the end of the fixed period. This savings method offers guaranteed returns, which are known at the outset, but you may miss out on potential income if interest rates increase during the lifetime of the bond.

Equally, interest rates could go down and you have actually earned more income this way. In this sense, fixed rate bonds can be viewed as a soft introduction to investing, whilst retaining the security offered by saving.

Pension

These can be a workplace pension or a personal pension, but either way a pension fund is a good vehicle to use to accumulate money to use for your retirement.

Pension funds can’t usually be accessed until you reach the age of 55, although there are exceptions.

The pros of saving

• Saving is low risk because your money is safe in an account, is earning an amount of interest and grows as you add more savings to it. This value will not go down, it will only go up.
• With regular savings accounts and most other forms of savings** you can add to and withdraw amounts of money as and when required**.
• Saving is a** quick and easy way to build money** to be used towards a project, or to retain as an emergency option.
• Saving can cover your everyday expenses in the event that you lose your job or fall ill and are prevented from working. This should allow for a seamless transition in income from your salary to your savings, and depending on what amount of savings you have built up, can cover these expenses and allow you some breathing space to get your life in order in the short to medium term.
• Saving is a relatively simple concept to understand and is something we are taught and are used to from an early age.

The cons of saving

• The overriding disadvantage of saving is that the monetary gains are usually low. Interest rates on savings accounts are typically around 1%, which means that if you deposited £10,000 in a savings account, in one year you would only earn £100 in interest. This is fine if you are only wanting to keep your money safe, secure and accessible in the short term, but in the longer term there may be better ways to use that money. Also, it should be added that there are some savings accounts and bonds which offer higher interest rates but tie your money in for fixed term periods.
• Ultimately, with saving you may find that your money’s value is growing at less than the rate of inflation and hence also the cost of living.

Investing is something of an art form, and is traditionally only recommended for those with knowledge and experience. In this sense, it is advisable to get good professional advice on the investment vehicle that is right for you, and to fully understand it, before you enter it.

That said, the investment world is changing and there are products in the market which offer a lower-risk entry-level introduction.

The common thread for most investments, however, is that they are a long term commitment. Only this way will you maximise your earnings from investment and make the commitment worthwhile, because over time you are roughing out the natural peaks and troughs which are bound to occur in the short term.

Equally, it only makes sense to invest money if you have the income to do it. Many investment vehicles require regular deposits of money and they definitely restrict your access to that money, so if you have an unstable income or are living on the breadline and struggling to support your family day-to-day, it may not make sense to be investing money in the hope of reaping the rewards in 20 year time, for example. Investing is about long term goals and should be viewed very much in that context.

What is the purpose of investing?

Investing money is effectively using capital to buy assets, in the hope and expectation that those assets will rise in value.

There are many different ways in which you can do this, but in principle, the common denominator in all investments is that you have to accept that there is no guarantee you will see a return on your investment, indeed there is a chance that you will lose money because your asset has reduced in value.

So whilst you can earn quicker and greater returns through investing than through saving, you have to accept there is some volatility in the market and that you may end up with nothing.

And equally, you stand a much better chance of earning money if you commit to a long term investment, which, generally speaking is a minimum of five years, as this tends to ‘ride out’ short term volatility to provide a better chance of earning positive returns over time.

People invest their money for a variety of reasons, it may be their profession because they are very good at it, it may be a hobby because they have inherited some money unexpectedly, but in most cases it is with a long term goal in mind.

This could simply be retirement, or it could be so you have money to contribute to a child’s university fund, or their first house. Whilst you need to choose an investment vehicle with an acceptable chance of growth – with professional advice you can be guided towards investments of low-risk, medium-risk or high-risk prospects – you also need to choose one that will mature and give you access to your money when you need it.

For example, there is no point in investing in a product that matures in 20 years’ time, if you need the money for your daughter’s university degree which will most likely start in five years’ time.

How to invest money

Stocks and shares

You buy a share of a company on the stock market and watch the value of that share rise or fall, you then sell the share at the right time, ideally when it has risen to an acceptable value.

However, shares can also plummet in value and then show signs that they are unlikely to rise to the value you bought them at, and hence you might decide to cut your losses and sell.

Investment bonds, funds and trusts

These are investments which pool together money from lots of individuals, including yourself. A fund manager then invests the money in a wide range of assets, which could be UK shares, overseas shares or bonds.

Each investor is issued units, which represent a portion of the holdings of a fund and these units will rise or fall in value.

You can build a portfolio of different bonds, trusts and funds which represent the level of risk you are comfortable with, and which, therefore, will be mirrored by different levels of return, ie. higher risk = higher return.

With these forms of investment, you are usually tied in for longer term periods, before the product will mature and give you access to your money.

Property

Buying a second property – ie. on top of your own residential property – and either developing it to sell for a higher price or renting it out for regular income.

This is a less risky form of investment as the property market is generally more stable and predictable, people tend to understand the property market better and can control their decisions easier.

However, your money is still influenced by market forces and there is no guarantee of a return on your investment.

Business investment

You can invest in a business – often through a friend, relative or work colleague, but it could be through anyone - and earn money through profits or an annual dividend. Again, much like stocks and shares, there is no guarantee that the business will perform well enough to earn you some income.

Crowdfunding and P2P lending

This is a relatively new form of investment, where you invest along with a number of other people and your exposure to risk is limited only to the % share you have bought. For example, you invest in a project which needs money on the agreement that you will get your money back plus an agreed amount of interest.

It should be noted that this isn’t risk free, as funding opportunities can hit issues, delays, or not be profitable when all is said and done, which places invested capital at risk.

The pros of investing

• Potential for larger gains if you are able to commit to an investment for more than five years, as a rule of thumb.
• There are lower-risk investments which** offer better returns than a savings account** or any other form of saving. And even this low-risk form of investment will most likely beat the rate of inflation in terms of increasing the value of your money.
• Online portals make investment easy and accessible, as well as being transparent and easy to follow and analyse.
• It is possible to follow professional advice and build a diverse portfolio. This spreads your risk across different types of investment with different risk ratings, and generally means that if one investment fails to perform, your overall wealth is balanced out by other investments which perform more successfully.

The cons of investing

• Investing money can be high risk and the value of an investment can plummet rapidly, so it is possible, for example, that you could lose 50% or more of your investment over a one year period.
• In most cases your money is not accessible and will have more chance of earning a return if you don’t touch it.
• Investment markets can be complicated to understand and off-putting for the novice investor, and without professional advice it can be easy to make mistakes.
• **Investment markets can be volatile and open to trends that you can’t control **and may struggle to understand, and also, in extreme cases, you are exposed to the influence of worldwide events on the economic climate, such as the 2008 banking crash and the 2020 COVID-19 pandemic.

A simple conclusion to make when considering saving versus investing is that saving is for people with a short term goal that they need money for, and investing is for people with a long term goal that they need money for.

The specific time periods therein can be defined by the saving or investment product you choose, but as a general rule, if you are looking at a short term investment as a get-rich-quick scheme because you need money quickly, this could be a risky strategy.

Of course, there is much more to it than simply having short and long term goals though. We started by explaining that money offers a form of security and you need to decide what kind of security you need, be that short or long term, or for either a specific project or as an income in retirement.

Ultimately, if you are looking at saving or investing and are not currently doing either, you should definitely decide now, and do one or the other, because each day wasted is an amount of potential earnings you are missing out on.

There is a way you can combine both saving and investing, because it is true that you may need cash reserves to hand whilst other money is tied up in investments, and those reserves come from savings.

The alternative is to cash in an investment early and miss out on possible earnings, which is a waste. So your strategy for building wealth can be a combination of both saving and investing, and this is a sensible means of covering potential shortfalls and managing that magic word we mentioned at the start; liquidity.

Whilst there are vast differences in strategy and approach to both saving and investing, there are other similarities too. It is also true that both saving and investing can be started with a relatively small amount of money, and each requires an amount of commitment in order to get the most out of it.

In conclusion, whether you wish to save your money or invest it depends on your individual circumstances, your life goals and your ambitions, and this effectively boils down to what you need money for and when you need it; how liquid do you need your money to be? This will tell you whether saving or investing is right for you.