Investing is essentially the process of making our money grow. That process involves harnessing processes which are entirely outside of our control, and it always involves risk. I’m going to talk about risks in a stand-alone ultimate guide, because it’s a big subject.
The Difference Between Saving and Investing
It’s crucial to differentiate saving from investing. There are various ways to differentiate the two, but here are some rapid-fire thoughts to help you understand the difference:
Saving involves putting money in the bank, investing involves buying real assets.
When you put money in the bank, it doesn’t do anything for you, except maybe attract a bit of interest. But the point is it’s there, it’s accessible if you need to take that money out of the bank and spend it on something.
When you invest, you convert that money into something else like a property, a share, or a lump of gold. Those assets will hopefully make you more money in time, which is the main point of buying them.
Saving is short-term, Investing is long term – When you save money, it is likely to be used in the next three years, for things like Christmas, next year’s holiday, or your anniversary the year after next.
When you invest, it is towards things which are more than four or five years into the future. Things like your kids’ private education or university costs, your daughter’s wedding one day, or the big one: your retirement.
When saving, you earn interest, when investing you get ‘total return’ – Money held in the bank will earn interest. It’s the bank’s way of paying you for letting them use your money for their other projects, like lending to mortgage borrowers. If you buy assets, you usually get two strings to your bow.
You can earn an income in the form of interest or dividends, or if you own property, your income is rent. You can also benefit from the assets you bought rising in value. The combination of the two is called total return. You’ll often hear ‘total return’ shortened to just ‘return’ or ‘returns’.
Saving will not produce wealth, investing for the long term will – Keeping your cash in the bank is no way to build wealth. Interest rates are currently at record lows, have been so for more than a decade, and are likely to remain so for a while, so you’re not getting much for leaving your cash in the bank. Worse, as the interest rate is below the level of inflation, the value of your money held in the bank is actually declining in real terms.
Money which is invested, on the other hand, tends to increase in value over time. It doesn’t always happen in a straight line, but usually investments comfortably outperform inflation over the long run, so the value of your money increases.
Saving is risk-free, investing involves some risk – Cash in the bank is generally considered risk-free. Deposits in banks in the UK are insured by the government under the Financial Services Compensation Scheme (FSCS), up to £85,000 per person, per bank.
Even if your bank fails and your money is lost, the government would step in and pay you the money back, up to that level. Investments come with all kinds of risks, as we’ll talk about alter in the series. Far from being a bad thing, risk is part of the engine of wealth-building.
Saving has no explicit cost, investing has costs – Most banks don’t charge you for depositing your money with them, though some banks do charge for current accounts which are enhanced with benefits like travel insurance.
Investing involves various levels of charges. There are transaction costs, platform, wrapper and account costs, taxation and sometimes advice costs. Needless to say, in order to offset these costs, you hope to do better by investing than you would by leaving your money saved in the bank.
Saving is rate-driven, investing requires knowledge and education – When deciding where to save your money, the best choice is likely to be the bank offering you the highest rate of interest. These days you can compare hundreds of bank accounts easily using comparison websites. One bank is much the same as another and as long as the FSCS protection applies, you might as well shop around for the best deal.
When it comes to choosing investments, there are many other factors at play, such as the past performance of your chosen shares or funds, the state and outlook of the world economy, the ease with which you can take your money out, and more factors besides. Because of this, you need to do a bit more homework than spending five minutes on a comparison site.
So you see – saving and investing: two very different animals. They’re structured differently; there are charges involved with one, risks with one and not the other… but there are benefits as well as differences; pros and cons to both.
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