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Saving and investing are essential to your financial security, however, the two terms are often used interchangeably. While related, there are some stark differences between the two. They serve different purposes and play different roles in both your financial strategy and balance sheet. To achieve the lifestyle of your dreams and in order to secure your financial future, you need to both save and invest and whereas one will help you reach your short and medium-term financial goals, the other will drive you to reach your long-term objectives.
Yet, whether you have been working on your finances for years or you have just started doing so, it can be difficult to decide when you should be saving and when you should be investing. Here is what you need to know so that you can choose the right product for your needs.
From purchasing a new car to paying for different home improvement projects and booking for your summer holiday to the Caribbean – these short-term goals and any other emergency that you may face at some point or other will require you to have some money saved.
Saving is the process of putting cash aside and storing it in a safe and liquid account like a bank’s savings account, while it is considered the ideal option if you will be needing the funds in the near future and would like easy access. You are usually allowed a number of withdrawals a month without incurring any penalties. In addition, you may also earn some interest on your balance although this will be relatively low.
Before delving deeper into the advantages and disadvantages of saving, you must first consider the financial goals that could possibly call for saving as opposed to investing. As mentioned earlier on, the primary feature of saving is that your money is easily accessible for when you need it. For instance, market cycles – which refers to the trends or patterns that develop during different markets such as the stock market – typically take place every 5 to 7 years, so if you need the money in less than that time frame, depositing in an account is the way to go. Also, bearing in mind that your money will not grow significantly, saving is appropriate for those goals that you can fund yourself.
In addition, savings accounts are also very easy to open, while you can withdraw and deposit money anytime and in a variety of ways such as though ATMs or via online banking. What’s more, there are minimal fees involved, while the startup amount can be as little as €100 or €200 depending on the bank. Not to mention that saving is generally a pretty straightforward thing to accomplish which requires no prior knowledge.
In contrast, one of the greatest disadvantages is that you may not earn the highest potential yield, while the interest rate does not usually keep up with the average cost of living and as a result, you tend to lose some of your money’s purchasing power over time due to inflation. Another disadvantage is that most traditional banks compound your savings account interest monthly and at times even annually so your money’s full potential is not always realised.
Investing money is the process of using capital to purchase an asset which in return will generate good returns over time and help your money grow or provide a regular income. It is also a good way to participate in the global financial markets. For example, you can share in on the success of a profitable company if you buy a company’s stock or you own a mutual fund that invests in your preferred organisation.
Whereas saving in a bank account can help you accumulate money so that you can fulfill your short-term goals, investing is more essential for long-term goals. These could include your retirement plan, your children’s education, the deposit for a house you plan to buy in 10 years’ time or more, a financial legacy you would like to pass down to your loved ones or fulfilling a lifelong dream like starting your own business. As a result, investing is a smart strategy if you do not need your money right away.
Investing you cash comes with several benefits. Enabling your money to grow faster in the long run than it would in a savings account, the longer you invest, the more your returns will compound. So apart from earning a higher rate of return on your investments, your investments earnings will also earn money over time. Investment products like stocks, bonds and ETFs are highly liquid so they can easily be converted into cash and if your portfolio is diversified enough, not only will you limit any potential risks, but you should be able to beat inflation over time and increase your purchasing power. At the same time, you can make your own decisions as to how to allocate your funds in your portfolio, always taking into account your investment criteria, your financial goals, your investment horizon and most importantly, your appetite for risk.
Investing your money also has some challenges. For instance, due to market movements, the value of your investments may fluctuate. This means that your investments will increase in value when financial markets are doing well, the economy is improving or a company’s profits are growing, however in the short-term, investment prices of even the best investments could go down. For most people investing is for the medium to long-term whereby they invest and hold onto good companies or products which have historically provided good returns or income.
It is important to note that returns are often not guaranteed, so make sure you weigh each investment according to your risk profile and your objectives. At the same time, investing can be complex, most especially if you have no prior experience, so you might need help from an expert.
Perhaps one of the major differences between saving and investing is risk, however, there are several more that you should be acquainted with. Have a look at the table below.
Bearing in mind the various risks involved, it is important to invest wisely. You will have a better return if you invest early, while understanding the different investment vehicles, how they work and how to use them is imperative to being successful. At the same time, remember to always consider your investment objectives before taking any decisions. Is your goal to build a retirement fund or help your children pay for their first property? And what is your timeframe and tolerance for risk? If you are young, you can afford to be more aggressive with your investment strategy since you have sufficient time to ride out any inevitable rough patches. But as you get older, your investments should be less risky and more conservative.
When it comes to saving money, your main option for doing so is to open an account and make regular deposits, but when it comes to investing, there is a wider range of alternatives. Here is an outline of the most common investment products available:
Equities (Stocks) – also known as stocks, equities are securities that represent ownership of a fraction of a company, which entitles the stockholder a proportion of the corporation’s assets and profits equal to how much stock is owned. Equities are mainly bought and sold on stock exchanges, while historically, they are known to outperform most other investments over the long run. Units of equity are called shares.
Bonds – a fixed income instrument since they traditionally pay a fixed interest rate known as the coupon, bonds represent a loan made by an investor to a borrower, usually a company or the government. Bonds have maturity dates whereby the principal amount is repaid back in full, while bond prices are closely linked to interest rates, so when rates go up, bond prices fall and vice-versa. Would you like to learn more about bonds? Read through this article.
Mutual Funds – made up of a portfolio of equities, bonds and other securities, mutual funds pool money collected from several investors who invest in these securities. This means that investors have access to a diversified and professionally managed portfolio at a low price and each shareholder participates proportionally in both the gains and the losses of the fund.
Exchange-traded funds (ETFs) – an ETF is a basket of securities containing different types of investments like stocks, bonds and commodities. It can also have a mixture of investment types, while it often tracks an underlying index such as the S&P 500 index. Just like stocks, these are traded on an exchange, while an ETF’s share price will change throughout the day as the shares are bought and sold on the market. A more cost-effective and liquid solution compared to mutual funds, ETFs offer low expense ratios and fewer broker commissions than buying individual stocks.
When it comes to reaching your financial goals and preparing for the future, you do not necessarily have to choose one strategy over the other. Neither is better in all circumstances, and actually both are important to improve your current financial position and help you reach your plans for the future. In effect, most people benefit from both saving and investing so you should try to achieve a healthy mix between the two.
As a general rule of thumb, your savings should cover all your personal and household expenses, as well as your loan payments. In this manner, you will not have to live paycheck to paycheck. On the other hand, investing is more appropriate for money you are trying to grow over time.
Remember that a common goal between the two is that they are both strategies that help you put money away for a future purpose and accumulate further funds. If, however, you have opted to invest, you should make sure you get the appropriate advice needed. Here are some important questions you should ask before making any investment.
Still not sure where you should put your spare cash? Our financial advisors can help you make that decision by taking into consideration your individual needs. Get in touch with one of our financial advisors to set yourself up for success.
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