Saving vs. Investing: Where to Start?
Saving and investing are both important financial strategies for securing future financial stability. Both have their place in your overall financial plan, but it can sometimes be confusing to parse whether you should be saving or investing, at any given stage of your financial journey.
At a very basic level, investing is the practice of buying assets that you believe will increase in value in the future. Saving is the practice of putting money away in its most instantly accessible form for unforeseen problems or challenges. While both are important, it’s important to know when to use each strategy.
By saving, you are safeguarding your more immediate future with instant-access cash for emergencies. However, you are also restricting your potential financial expansion. There’s no chance of you growing your money beyond the small amount your bank will pay you in interest rates unless you invest properly.
For beginners with limited knowledge in investing and/or saving, this piece will guide you through the basics.
Should You Save or Invest?
Situations where saving is advantageous:
Saving is by far the less complicated of the two options. While the majority of banks will offer you insulting return rates on savings accounts, they are regularly well below the average rate of inflation which often results in a net devaluing of savings over an extended period of time. This means that the strategy of putting money in a savings account is most useful for short to mid-term applications.
Savings are useful for situations where you know that you will need the entire sum of money back within about a year. For example, if you know that you’re going to buy a house at some point within the next year or two, it might be a safer move to save your earmarked house money instead of investing it. Saving is also useful for preparing to pay larger bills, such as tuition, the downpayment on a car, or taxes. If you don’t expect any large payments to be in the next calendar year, it may be a good idea to consider investing the money.
Situations where investing is advantageous:
Investing is most useful for long-term applications and goals.
When investing, you are making a bet that the markets you place money in will rise, while assuming the risk that they could actually fall. Market fluctuation is a reality that all investors have to come to terms with, so it’s important to also consider how long you plan to keep your investment in for.
One of the most important advantages of a sound investment plan is that you are likely to be able to beat inflation. The average inflation rate in the U.S. over the past decade was 1.99% per year. While the inflation rate has fluctuated radically, (this past year it was 5.4%, arguably due to the effects of the COVID-19 pandemic) this is a good baseline for calculating average inflation over a longer period of time. The average interest rate that you’ll get out of a saving account in a bank is .06% per year, meaning that over longer periods of time the value of your saving account will drop relative to the inflation rate. Because of this almost guaranteed drop in value over the long-term, investments are far better at holding value over time, and often grow in value.
Money that you know you won’t need in the next couple of years will probably serve you better in some kind of investment account. When accounting for inflation, the average well-placed investment returns around 6% of its value per year. While it’s important to remember that this will probably fluctuate greatly from year to year, this number is about as close as we can get to a rule of thumb for average annual investment returns. The longer the term of your investment, the closer to this average 6% return you are likely to see.
Essential Steps To Take Before Investing
Before you invest anything, it’s a good idea to wipe your financial slate clean so that nothing can derail your financial success later. You can accomplish this by:
- Paying off any debt with high interest rates, such as credit card or overdraft penalties. Interest payments on debts such as these can offset future investment gains.
- Making sure that you have a back-up fund of between three and six months’ earnings. This is money for emergencies such as medical bills, vehicle repair, or other unforeseen challenges.
Think Carefully About Why You Want To Invest
It is vital to understand exactly what is motivating you to invest. Ask yourself some key questions before you begin any investment journey for the wrong reasons:
- How much of my initial investment am I willing to lose?
- Am I financially secure enough to avoid selling if my investments drop?
- What is the length of time I am content to leave my money tied up for?
- Am I comfortable tying my money up in investments for a minimum of five years?
- How much capital can I afford to invest?
- What are my specific long-term investment goals?
Selecting A Platform That’s Right For You
The easiest and cheapest way to invest is through an investment platform, whether you are a novice or an experienced investor.
Similar to when you purchase casual clothes or accessories, there are marketplaces for buying and selling shares and funds often known as “fund supermarkets”. Many of these (and certainly the reliable ones) will contain websites and apps to help walk you through the investment process itself. However, the process of investing also comes with inherent costs and fees. You will typically be charged three types of fees:
- One for using the platform (seperate from the management fee)
- Another when you buy or sell your investment
- If you invest in a fund, you will also have to pay a management fee
Use a Wrapper (Tax-Free)
There are government-approved tax-free wrappers available to take advantage of. Many users say that they are an ideal place for your investments due to the security and benefits associated with them. These include:
- ISA’s (specifically stocks and shares ISA’s)
- The aforementioned options protect your investment profits from capital gains tax and dividend tax.
What can I invest in?
Common types of investments may include but are not limited to what is discussed in further detail below. Always limit your investment to something you truly understand, or at least have received guidance from a financial advisor about.
If an investment product seems complicated and you’re struggling to wrap your head around it, it’s wise to consult a financial advisor before making a decision.
A share is a tiny fragment of a company. When you buy a share, you own a piece of that firm. When the company performs poorly, you will lose money. When the company grows, you will earn returns on your investment. You earn money in the form of the value of your shares rising. While many companies also pay dividends, much of the value of your investment remains in the value of the share that you bought, as you can generally sell that share at any time.
Investing in Shares: The Pros
- You have the ability to choose the specific company you want to buy stocks for, allowing significant flexibility and agency.
- You may reap substantial rewards if the company is successful via share price increases and dividend payments.
- When you purchase shares with most companies, they allow you to give input on some aspects of the direction of the business, allowing you agency in company-wide decision making.
Investing in Shares: The Cons
- Purchasing stocks with a firm that performs badly puts you at risk of losing money.
- Buying shares can decrease your immediate liquidity, making it harder for you to immediately regain your initial capital in a crisis situation.
A bond is an investment tool that is essentially a means of lending money to a company or country. You get paid a set amount at the end of the agreed period, usually after the bond “matures.” In addition, you receive regular interest payments commonly referred to in the business as coupons.
Investing in Bonds: The Advantages
- Bonds are generally considered lower-risk than shares by the majority of experts.
- Some bonds are secured, meaning that they are guaranteed to be paid back to you, even if the company or country becomes insolvent.
Investing in Bonds: The Disadvantages
- Your investment returns are likely to be smaller than the returns you might reap from buying shares of a company.
- Bonds do not generally give you any control over the company’s decisions or direction.
Rather than choosing your own individual shares, you can put your money into a mutual fund. This is essentially a group of shares, though managers can invest in other types of asset like bonds. If buying a share is like picking the MVP of a basketball team, a fund is equivalent to backing the entire roster.
So if one player doesn’t do well, there are others who can compensate for this. You generally have a straight choice between passive funds that track a stock market or active funds, where a professional investor picks stocks on your behalf.
Investing in Funds: The Advantages
- To decide which shares and range of assets to buy and sell, a fund manager utilizes their experience and expertise.
- Funds are often less risky than individual shares because they include many types of investment.
Investing in Funds: The Disadvantages
- A fee is charged by all fund managers.
- Despite having a range of assets to balance risk, the overall value can still drop.
How Much Capital Is Wise For A Beginner To Invest?
How much you should invest initially depends greatly on your financial goals and situation. It’s always a good idea to have an emergency fund of at least three months’ earnings in a savings account before you invest.
You should be prepared to leave your money tied up in your investment for at least five years, giving it enough time to grow. Some investment platforms let you invest with just a few dollars. You may want to start with small amounts at first in order to try out the features before investing a greater portion of your savings.
Is It Best To Use A Lump Sum Or Regular Savings?
Investing a lump sum will get your money working for you immediately, compounding any returns from the start. However, if the market dips, the whole sum will be exposed to the fall.
If you drip-feed a predetermined amount of money into the market over time, it can smooth out the highs and lows of the market. In other words, the same amount of money will buy fewer shares when prices are high and more when they are low. One of the drawbacks of this strategy is that you can miss out on the full benefit of potential rises in the markets in the early years because you will have a much smaller sum of money invested to begin with.
Deciding between investing and saving is a complicated process that requires self-knowledge, and sound understanding of the financial system. While you can make some of these decisions on your own, it is usually a good idea to consult with a professional. Financial advisors can inform your decision to either save or invest, and can also help you choose how best to proceed with either of these options. Whether you are fully financially stable or are just starting out on your financial journey, it’s critical to choose well between these two overarching options, and be able to proceed with financial confidence.