People often get confused between saving and investing.
It doesn’t help that the words are sometimes used loosely and interchangeably. In reality, though, there is a clear difference between them.
What is saving?
Saving is setting aside some of your money for the future. Often people save for a particular purpose, e.g. towards a wedding, a holiday, or a house deposit. But you may also save just to build a pot of money for any contingencies that may arise.
Saving is generally done via a cash product such as a bank or building society account. If you save with a government authorised financial institution, your money will be protected by the Financial Services Compensation Scheme (FSCS) up to £85,000.
This means there is no risk of losing your money, even if the bank fails. Interest rates are currently very low, however, so over time the spending power of your savings will be eroded by inflation.
What is investing?
Investing also involves setting money aside for the future. Rather than putting it in a cash savings account, though, you put your money into something you hope will grow in value over time.
There is a huge range of things you can invest in, some riskier than others. They include everything from fine art to property.
But perhaps the most popular (and most suitable for new investors) is stocks and shares. In this case, you are buying a tiny fraction of a company. If the company is successful the value of their shares will rise over time. You may also receive a portion of their profits in the form of dividends.
- For novice investors, funds – which are basically diversified collections of shares – are likely to be a better choice than individual company shares, as the risk is spread more widely. This is discussed in more detail below.
Unlike saving, when investing you are taking a risk that the value of your investment may go down rather than up. But investing also offers the potential for better returns than saving, especially in the longer term.
Over most five-year periods stocks and shares have outperformed cash, and in almost all periods of 10 years and more.
So, which is best?
You may not be surprised that there is no simple answer to this question. Ideally – as it says in the title – you should do both. Saving should, however, be your priority, as I’ll explain below.
Before you even consider investing, it’s important to ensure you have some money in reserve in an easily accessible savings account. The rule of thumb here is three to six months’ worth of expenditure. This money will be a lifeline in the event of an emergency, e.g., an accident or illness, losing your job, etc.
After that, if you have any spare cash, you should pay off interest-charging debts such as personal loans. You may also want to save for a specific event if you know it will occur in the next few years. If you still have money available after that, you can – and probably should – consider investing.
As mentioned above, investing offers the potential for significantly better returns than saving, as long as you aren’t likely to need the money within the next five years or so. This timeframe should allow the inevitable ups and downs in the financial markets to even out.
As for what to invest in, for new investors I recommend a fund containing a broad range of shares, bonds and/or exchange-traded funds (ETFs). Vanguard UK is one popular low-cost provider. Another possibility is a robo-adviser platform such as Nutmeg. (Disclosure: I invest with Nutmeg myself.)
A good blend of savings and investments can ensure your wealth grows steadily over the years and you are well-prepared in the event of any setbacks.
Disclaimer: I am not a qualified financial adviser and nothing in this post should be construed as personal financial advice. All investment carries a risk of loss. You should always do your own ‘due diligence’ before investing and consult a professional financial adviser if in any doubt how best to proceed.
Nick Daws writes for Pounds and Sense, a UK personal finance blog aimed especially (though not exclusively) at over-fifties.