Saving & Investing: The Difference
The key differences between saving & investing you need to know
What’s the difference between savings and investments, or saving and investing? Is one better than the other, or should you aim to have both some savings and investments as part of your personal finances portfolio?
Fortunately, both savings and investments are pretty easy to understand. Let’s start with savings.
What are savings?
When we talk about savings, we’re talking about a savings account, not keeping your money in a shoe box under the bed. Why? Because savings accounts protect your money, and come with interest.
Savings refers to the amount of money you have in an account, which is yours to use for whatever your goals might be. You can use a savings account to save for a holiday, a car, a house, or anything else.
But one popular reason people have savings is for emergencies. A broken boiler, a problem with your car, or a medical issue, things which can’t always be predicted but which usually cost a fair bit of money.
The pros of savings
Build an emergency fund — Relying on invested funds for emergencies is risky, as you might not have what you need, when you need it.
Reach your financial goals — Savings give you a solid and predictable way of moving towards a goal, whether it’s a phone, holiday, car, or house.
Low risk, predictable yield — Money in a savings account isn’t invested, and is protected, so you’re unlikely to lose it. You’ll also see the interest rate upfront, and depending on your terms, know for exactly how long you’ll receive that rate.
Cons of savings
Lower yield compared with investing — Investing involves more risk, which can yield higher rewards and profits. Savings are less risky, and so don’t have the potential to pay as dramatically.
May lose out to inflation — Depending on how much inflation rises, you might devalue the money in your savings account. For example, if your savings account interest rate is 2% but inflation is 4%, your money isn’t keeping up.
What is investing?
Investing is when you stake your money in a company’s performance. When you invest, you buy a share of a company (you own a piece of it). The company then uses your money to fund its operations, be that building new products, or expanding into new areas or locations.
When you invest, you’re saying, ‘I believe that this company will do well and make me a profit on my investment’.
If that turns out to be true, the value of your shares will go up. Conversely, if the company under-performs, or demand decreases, the value of your shares can go down.
Risk in investing
Your risk appetite, or how willing you are to risk your money, is a big part of investing. High-risk investments often come with higher short-term returns, compared to lower-risk investments.
Diversification is important here, because you probably don’t want to put all of your money into high-risk investments. A diverse portfolio can make it easier to stomach any dramatic changes (particularly dips) in your portfolio.
With investing, as with saving, it’s also important to think about a long-term plan. While your investments might fluctuate wildly month by month, over the longer term (years), a picture emerges that’s easier to understand.
The pros of investing
Potential for higher returns than savings — Your returns are based on a company’s performance, which can change dramatically in both the short and long term.
Can help achieve long-term financial goals — If your goal is to multiply your money as much as possible (keeping in mind risk), investing can help you achieve this.
Diversification can reduce risk — Having some lower-risk, dividend-paying investments can help balance your portfolio and provide some passive income.
The cons of investing
Risk of loss, especially in the short-run —Businesses make mistakes, demand changes, and pandemics happen. These things can cause short-term losses for investors.
Requires discipline and commitment —Seeing your investments rise and fall in value can be an emotional rollercoaster. Being able to stick it out (and know when to cut and run) is important.
May require longer time horizons — The most successful companies can take years or even decades to yield considerable returns for investors, making patience one of the investor’s most important virtues.
Should you save or invest?
You probably know the answer by now having read this article. Having some sort of savings is always a good idea, as emergencies happen and being able to cover them is crucial.
Depending on your goals, both short- and long-term, a diverse investment portfolio can also be a great thing. Knowing what you want to achieve and when is the first and most important step towards deciding whether you want to invest as well as save.