Saving vs investing

Should you save your money or invest it? Saving and investing are two very different approaches to money management, with their own benefits and drawbacks.

Saving money is a way of protecting your wealth while investing money is a way of growing wealth. While saving money is generally considered a good way to guard money, it's not without risk. The longer savings sit idle, the less they can buy because of the effects of inflation. Similarly, investments come with their own set of risks, which is why it’s a good idea to do a bit of both.

What exactly does it mean to save money?

Saving your money involves setting aside a certain portion of your income or wealth in a savings account at a bank or at an investment house. Savings accounts are a fairly safe place to keep your money, as this segment of the financial services market is very actively regulated. In fact, in the UK all bank deposits and cash savings accounts come with a de facto guarantee on the first £85,000 that you have saved. That means that even in the unlikely event that the bank fails, you will still be able to get at your money back.

For many people, the security of a savings account is the biggest draw. This helps to justify the historically low interest rates that are offered by banks on their savings products. The lowest rates are reserved for instant-access savings accounts, where you’re effectively paying for the privilege of being able to withdraw cash at any time. Better rates will be available on notice accounts, where you must inform the bank of your intention to withdraw money several months or even several years in advance.

Saving money regularly is a great habit to build, especially if you can start young. However, there is a limit to the amount of money that you can earn through a savings account, as the interest rates are the lowest on the market. Furthermore, if the rate of inflation outpaces the rate of your interest rate, your money will be losing value year-on-year. The risk in saving therefore increases with a longer time horizon.

What does investing involve?

Investing involves putting your money to work by buying assets that increase in value over time. Selling those assets at a higher price than you paid for them increases your wealth. Assets can be physical, like houses or jewellery, or financial, like shares and bonds.

Investing comes with a higher risk than saving, but the risk is usually balanced out by the potential for higher returns. While a cash savings account might pay no more than one or two per cent per annum, investment returns can reach double digits (or even higher).

A good investment portfolio should be diverse and well balanced to minimise the risk of losses. If you put all your money into one stock, and that company’s stock value drops by 20%, you will have lost 20% of the total value of your investment. But if you spread your money across 100 stocks, that 20% loss on stock number one will represent a much smaller portion of your portfolio.

This is how a balanced, diversified portfolio can help you to reduce your risk. When you have 100 or more different investments, you can afford for a few of them to lose value. If the majority return a profit, your overall portfolio should still deliver positive annual returns.

However, there are no guarantees in investing and no matter how carefully managed your investment portfolio is, it's always possible that you could lose money. This is the main difference between a cash savings account and an investment portfolio. If you lose money through investing, you will typically have no recourse to claim your money back.

Finding a balance

There are pros and cons to both saving and investing. But taken together, these two approaches to finance can really complement each other. Cash savings can form a valuable part of a diversified investment portfolio as they can offset the risk of any losses from stocks and shares investments; while investments hold the potential to boost your overall returns far higher than any low-interest savings account can manage.

Before making any new investment decision, it's important to understand your individual risk profile. Most people will take one of three risk approaches: high risk, medium risk or conservative. A conservative investor may choose to keep a big portion of their money in a cash savings accounts, alongside other low-yielding, lower risk investment options such as government bonds and blue-chip equities. Meanwhile, a high-risk investor may keep a minimal amount of money in cash, with the majority in higher-risk investments such as penny stocks, where they hope to make enormous returns even though there is a danger of losing money.

Your own attitude towards risk as well as your investment horizon will help to dictate your portfolio make up, and how you find a balance between saving and investing.

And of course, your risk attitude can change as the economy and your own personal financial situation changes. Keep checking in with your investment portfolio and your savings accounts and make any adjustments as and when they are required.