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There is a great debate around saving vs investing, so which one should you pick? There are times when putting funds into a savings account makes sense and times where investing is the best option. This guide considers when may be best time to start saving and investing, how they differ, and how to get the potential returns from both.
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Investing offers several advantages, which vary depending on which assets you invest in.
The main advantage is return potential, which grows capital over time. For example, US stocks have, on average, risen 10% per year, while UK stocks have risen 8% per year over the long term. Bonds have averaged a 5% yearly return over the long run.
These gains can compound year after year as long as the capital is left in the account.
Returns that are above the rate of inflation allow capital to grow in real terms, such as stock and bond returns. Low returns, associated with savings accounts, typically return less than inflation, which means that capital is being eroded over time.
Investing can be tailored to each person’s risk tolerance, time horizon and goals.
Investments offer people the chance to make returns that beat inflation, therefore growing their capital. But this also comes with some disadvantages.
There is the risk of loss. While, on average, stocks and bonds have produced positive returns over the long run, there is a risk they could lose money over a given time period.
Investing takes more work than putting money in a savings account and never touching it. Coming up with an investment plan takes time, as does reinvesting capital from interest and/or dividend investments.
Savings, where money is kept in a savings account or fixed-term deposit, are an alternative to investments and have several advantages.
Savings have nearly zero risk of loss – unless the bank defaults. Losses in this regard are covered by the Financial Services Compensation Scheme, per eligible person, by up to £85,000.
Savings are easy to access, especially those in a savings account. Unlike an investment, nothing needs to be sold to get hold of the cash. Even fixed-term deposits can be quickly accessed, although if you withdraw early, the interest accrued may be lost.
Savings compound and interest is typically paid monthly. The interest received earns interest going forward if it remains in the account.
Savings are typically safer, but when compared to investing, there are some disadvantages.
Money in a savings account will typically earn less than investments, which have more risk over the long term. This means capital will typically grow more slowly than with stocks or bonds, for example, compared to when you are short-term investing.
Saving is important, but it also has an opportunity cost. Money that is saved isn’t being used for other things which may enhance your quality of life. But money saved now may enhance your quality of life in the future.
There are two main factors that contribute to how saving and investing are different.
The main difference is that savings are not in danger of fluctuating in value or losing money, while investment values can fluctuate, sometimes being worth more or less than what you started with.
Another key difference is that investments tend to produce higher returns than savings over the long run.
One isn’t better than another. Rather, they both serve a purpose and are useful for different things at different times.
If someone is saving up for something and they can’t afford to take any risks with that money, then saving that money (as opposed to investing it) may be a wise choice. Also, if someone is likely to need funds relatively soon, then saving is a better option than investing. People tend to prefer investing their funds when they don’t need the funds right away and when they are willing to take on some risk to make a higher return than a savings account.
Each person also has their own risk tolerance, time horizon and goals.
People who are conservative in their financial affairs, where capital preservation is paramount as opposed to growth, may favour having much of their wealth in savings and only some in investments. A person more inclined to take risks or wanting a higher return may opt to invest more heavily, leaving only a small amount in savings/cash. This depends on the allocation of your investment portfolio.
A shorter time horizon until retirement also tends to make people favour more conservative investments. Younger people with longer time horizons tend to invest more heavily, favouring stocks that provide a higher return than savings or bonds.
If you keep your funds in a savings account, shop around at the various banks and see who is offering the best interest rate. Over many years, a small difference in rate can make a big difference.
Also, you can consider putting funds into a fixed-term deposit. These are offered at banks and usually offer higher interest rates than a savings account. In exchange for the higher interest, you agree to keep your money there for a set amount of time. If you pull it out early, you may forfeit some or all of the interest. Usually, the longer the duration of the term deposit, the higher the interest rate.
Finally, if you are paying high interest on credit cards or other loans, consider paying those down with savings. The interest saved on a credit card is more than the interest earned in a savings account. If you’re willing to take more risk, then opening a stocks and shares ISA is a tax-free way to start investing your savings.
People often ask: “is now a good time to invest?”. Some investors decide to start as early as possible so that they can compound their investments, as the longer money compounds, the more it grows. When you invest, you can take advantage of the long-term rise in the stock market, the interest paid on bonds, or the dividends paid out by companies. The UK and US stock markets have risen, on average, 8–10% over the long run.
If you invest and make 10% this year, and then the following year, your initial investment plus your profit would make gains. Coupled with regular contributions to the account, Einstein called compounding the eighth wonder of the world. It takes time to work, though, so starting as soon as possible is ideal.
If you are interested in potentially getting higher returns on your capital, here is a checklist for how to invest savings:
FAQs
Not technically. An investment means something is purchased with the intention that it will produce a profit over time. With a savings account, nothing is purchased. It is cash kept on hand (at the bank) to be used when desired. That said, savings accounts may pay interest, so it is still making a return. It is a commonly used short-term investment method.
Some financial advisers would recommend saving for a house, as this way, your money isn’t likely to be lost due to fluctuating investment prices. That said, investing your down payment may be an option if you don’t plan to buy a home for at least several years. When investing, there is always the risk of loss, which is important to consider when investing your down payment.
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