People who are new to the world of personal finance are often asking the question – which should I do, invest or save?
There is no clear answer and this will very much depend on your personal situation and needs. There are however some rules that can guide you to the option that will suite your needs better than the alternative available.
Very often factors like your risk tolerance, financial goals and time available play the key role in what you should choose to do with the money available to you.
invest or save – the key difference between the two
Before we go into the detail of which of the two is better – we need to get clarity, what is the difference between investing and saving. Both of these are linked to personal finance and wealth creation. On top of that – both have their unique role in each investors portfolio.
Often the difference between the two will be measured in the amount of time it will take before you need to access your cash. Savings most of the time are very liquid and available mostly instantly. Investments can take significantly longer depending on the class of assets you invest into.
Don’t get me wrong, some cash savings will be sitting in a savings account that will have a certain period of time before it matures and becomes available. The option to brake the contract will always result in the holder of the account being liable to pay a penalty.
On the other hand investments will often have to stay in the market for longer. Something like shares are fairly easy to sell however at times this might come with a loss due to market fluctuation.
Other types of investments can be really illiquid. Examples of this can be property, art, businesses or vintage cars. It will take some time with any of the above for you to access your cash. Even if you sell at a loss and below the market – I highly doubt you will get your cash the same day.
The above are the reasons for you to make a decision before you choose one option or the other. It is worth keeping in mind – often time and risk levels are the secret ingredients to you getting high returns on the money you are putting aside.
when should you save
So let’s start by looking into saving in more detail. As mentioned above – saving money is a lot more liquid. The biggest issue with this however – the returns often are small and significantly below the rate of inflation.
For those who are not sure of the impact of inflation on your buying power – if inflation is above the rate of increasing value of your portfolio you are pretty much losing money. This is due to you being able to buy less goods than you were able to purchase before.
You would probably ask – if savings are so inefficient to tackle inflation, why would anyone want to lose money? The answer is simple – you are willing to accept the cost for your assets being liquid.
There might be numerous reasons for this. Some of these will include you looking for an investment in a near future, this being a way of storing your emergency fund or any other major expense that is coming up that you are aware of.
No matter the reason you have – make sure the money is kept in a savings account with a highest possible interest rate. One other thing to check for – you are allowed to use your money at any point without any penalties to pay.
Some savings accounts in the UK currently pay over 5% interest. One example of this is Barclays Rainy Day Saver account. There is a limit of £5k but worth keeping this option in mind.
If you are saving specifically for your first home – save cash in a LISA account. These accounts can offer you the benefits of cash ISA with an extra 25% on top of your investment that you get from the government. The limit here however is only £4k per year.
when should you invest
Investing is the complete opposite – people invest when they are thinking long term. This is normally 5 years and more. This is often for the purposes of retirement. Also, the financial freedom movement made many younger people look down the investment path.
The most frequent investment tools for this are often growth or value shares, dividend stocks or property. The assets you will choose will depend on your personal preference.
I personally would recommend building a diversified portfolio and include as many asset classes as possible. This will allow you to sleep better at night when one type of asset starts underperforming.
The benefits you get from different asset classes can’t be underestimated. The likes of stocks will often either pay a dividend or offer great value appreciation perspectives. Alternative to picking individual stocks – buy an ETF that covers a whole market. This in itself gives a great diversification while only investing in one financial instrument.
The likes of property is great for creating a cash flow. The cash flow can be used for many reasons as well as paying for you retirement later in life. Property also brings options of selling the underlying asset in cases when you need a large chunk of cash.
Alternative investment types are also a great option however you need to be an expert in these. Here I am talking about collectible wines, vintage cars or art. All of these can deliver great diversification and value growth however you need to understand what is worth investing into and what risks there are with alternative investment types.
summary
As you can see from the above – both investing and saving have their benefits and risks. There is a role for both in a well diversified portfolio.
The true art is for you to find the right balance. You need to have enough liquid assets that give you confidence in tomorrow no matter what might happen. However, you don’t want to hold too many liquid assets as these normally return significantly less that slightly riskier assets.
When it comes to the actual returns – your savings will usually bring you low single digit returns. Investments on the other hand can bring up to double digit returns over longer run.
Always remember to diversify and only invest into things you actually understand. This most of the time is the simple formula to long terms wealth and riches.