Should I Save or Invest?

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The choice to save or invest depends on your personal situation, and factors such as age, income, family, goals and if you want to put your money away for the short or long term. Hopefully this article will help you understand how each applies to your situation.

We are always told that’s it’s a sensible idea to save for our future whenever we can. And it’s true that putting away any spare cash, and starting to save from an early age as possible is usually a good idea. But the question is what are you saving for? If it’s for an upcoming purchase, such as a car or holiday, then you are likely making the right decision in keeping your savings in a current account or savings account with your bank. However, if it is for something further away, such as your retirement or a university fund for your newborn, then there is a good chance that your money would be better off invested in some way.

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Higher returns

When you open a savings account, you will know what your interest rate will be. This gives you the benefit of knowing what return you’ll be getting, allowing you to plan effectively. If you have a fixed rate then you’ll know exactly, if it’s variable then it will usually move with the Bank of England base rate, but you will still have a good idea of what to expect.

However, although you’ll know what you’re getting when you open a savings account, the rate is likely to be very low. Although an interest rate above zero means your savings will be growing in pounds and pence terms, you need to be aware that if it is below the rate of inflation, then your savings are falling in value (as you can buy less with the same money out in the real world).

So while keeping your money in savings can be safe and predictable, there is the issue of low returns eroding your wealth.

Investments, on the other hand, have a much higher potential for returns. The amount of returns can vary wildly, not only from year to year, but across different types of investments. Whilst they tend to fluctuate and are relatively unpredictable in individual years, they have historically grown over the years to give a much higher return than savings.

Over a 35 year period, if you have invested in a fund of large global companies (not including the USA) then you would have had an average return of 7.6% every year. But within that average, you would have had yearly returns as high as 68% and falls as big as 41%.

Investing in companies from emerging economies instead would have given you a higher average return (12.2%) but also much higher fluctuations, with yearly returns as high as 72% and falls as big as 53%.

The higher returns are one of the main reasons to invest, but it is the fluctuations in the returns that mean investing is only suitable for the longer term.

It’s important to note that past performance isn’t necessarily going to continue and shouldn’t be relied upon, and indeed this is one of the risks and why using a Regulated Investment Adviser can help steer you towards the right investments for you and help you understand the risks as well as the potential returns.

Risks

The difference in risk is often seen as one of the key differences between savings and investing. Understandably it’s the higher level of risk that put many off considering investing.

Savings in the UK are protected under the Financial Services Compensation Scheme up to a limit per person, per banking group (currently £85,000). Although it’s highly unlikely for a bank to go bust, if it does the government will reimburse your funds to at least the limit. NS&I is a popular place for savers and as it is backed by the government and so all funds deposited are completely protected, not just the first £85,000. With almost all savings accounts you will know what the return (interest rate) will be, with no risk of it changing.

Investing inherently carries a higher level of risk than with savings. With investing you are exchanging cash for an asset (shares, property etc) which you hope will either generate you an income, rise in value, or both. Importantly there are very few guarantees with investing and the main risk is that the returns are lower than expected or the value of the assets falls. The risk of not getting back what you put in is referred to as Investment Risk, and the key to investing is to understand the risks.

But not all risks are the same. If there’s a secret to investing, it’s getting to grips with and understanding the risks involved, what can be done to reduce them and when risk should be taken on. Investment risk can never be eliminated, but it can be understood and minimised and an effective investment strategy will look to reduce risk whilst maximising returns.

Whilst the returns and risks of savings are quite straightforward they are more complicated when it comes to investing (and this also varies across all the different types of investment). However, once investment risk is understood and managed then there is the potential for much more significant returns.

How long to lock away for

As discussed in the “returns” section, the returns on investments can vary significantly year on year, and it is only over the longer term that they have trended upwards. This is in contrast to savings where the income is largely predictable and can usually be withdrawn at very short notice. It is this short term unpredictability in the value of investments that means it is largely unsuitable for money which you need quick access to. A rough rule of thumb is that an investment needs to be made for at least 5-7 years to remove the risk from short term fluctuations in the value of the investment (and that some investments can take time to sell).

All other things being equal, one of the simplest ways to work out if it’s best to invest or save is to determine how long the money can be locked away for. If you are certain to not need the money for at least 5 to 7 years then this may be more suitable to invest, but if you may need the money sooner then it is unlikely to be suitable. If the money is an emergency fund or a deposit for a house purchase in the next couple of years then investing is probably not the best place for the money. The temptation is often there to “boost” a house deposit over a year or 2, and whilst in theory shares and funds can be sold very quickly to generate cash, you are exposing yourself to the risk that when you find the house you want the market might be down, leaving your deposit much shrunken.

Choices

With savings you’re pretty much stuck with the traditional offering of a bank’s current/savings account or Premium Bonds. While there are some choices between fixed/variable rate etc there are generally few options of where to put your savings.

This isn’t the case with investments which come with a large range of options; even just looking at shares there are a wide range of different companies that can be invested in, both in the UK and across the world.

When it comes to choosing the right investment(s) for your situation the increased choice can be useful to help align what you invest in to your personal situation. This can be because you have a long time horizon (so may want to invest in emerging markets) or because you have an ethical view.

For example, saving ethically can be difficult as most high street banks have invested in and lent money to companies that can be seen as unethical. With investing your own money you can choose where it is invested in, and with many more ethical funds being set up this is becoming increasingly popular and easy to access.

Protection against inflation

Inflation is the continuous increase of prices each and every year. It can be hard to notice day to day, but when you think back to how much something used to cost a few years ago (houses, stamps etc) you can get an idea of how much it builds and compounds over time.

The continuous rise in prices means that your money can buy less and less and if effectively decreases in value. Or in other words, you need to be matching the rate of inflation just to stand still.

The potential for greater returns with investing can sometimes be seen as “not worth the risk” but what many don’t realise is that the risk of doing nothing is seeing the value of your money and wealth fall.

Although you may know exactly what interest rate you will get on your savings, inflation is impossible to predict, so you can never have a risk free chance of beating inflation (apart from a few occasional inflation-linked savings products). The higher returns that can be earned from investing are often used as a way of protecting against inflation. There is risk involved in investing, but there is also the risk of your money losing value over the years.

Inflation has been running at around 2% a year recently, though of course it’s impossible to predict how that will change in the future.

Ease of access

Although there are some savings accounts that limit when you can withdraw in general you can gain access almost immediately to your money. In contrast, investments can be a lot more difficult to withdraw your money from.

The time taken to turn your investments back into cash (“liquidating”) can take time. Although many larger listed company shares can be sold and the cash withdrawn within minutes many other investments can take days or weeks to turn into cash. And if your investments are invested in a scheme such as a pension or a LISA then there may be other rules that make it very difficult to access your cash whenever you like.

This makes it much harder to quickly access your funds if they are invested rather than in a normal savings account.

Final thoughts

Deciding to invest your money can be a difficult decision to make as is it can seem daunting at first. However, for many it is worth exploring as the benefits can be significant.

Talking to an Independent Financial Advisor (IFA) who covers Investment advice is a sensible place to start as they can talk you through any questions you may have and explain the process, including risks, costs and benefits. Most good IFA’s will offer a free initial consultation to talk through your situation so you can get an idea of exactly how much financial advice can help you and how much it may cost.