Saving vs. Investing? What is the difference
Never has there been a more relevant time to talk about our personal wealth and the ways in which we can secure our financial future in what is a time of great uncertainty.
There’s a lot of information around but how do you really know what is right for you? Your family? Your circumstances? Would you be better off saving or investing?
What is saving?
Saving involves putting your money into a savings account that you use to accrue interest, growing your initial deposit. Savings accounts can be a great way to save towards a goal.
Some investors, such as those with a self-managed super fund, use a savings account as part of their investment portfolio, in order to guarantee receiving some kind of return on their money.
The rate at which your savings account increases is determined by the interest rate offered.
What is investing?
When you invest you put your money into a financial instrument such as shares, property or bonds with the intention of generating profit or income. Investing is never risk free, there will always be a level or risk. Often the greater the potential reward (profit) the more risky it will be. For example, shares tend to be more volatile therefore more risky, but you will likely generate more profit through shares than bonds, which are considered less risky. Risk vs. reward is a fundamental concept of investing.
What is the difference between saving and investing?
Saving is sometimes considered a type of investment, because the intent is the same as investing as you are putting your money into a financial instrument in order to grow your deposit.
The biggest difference between saving and investing is the risk they carry. When you save you put your money into a savings account which is very low risk, it is almost guaranteed that you will make some sort of return. As previously mentioned, investing always involves risks, although some products carry less risk than others.
Another key difference between saving and investing is the liquidity. When it comes to your saving you should be able to access that money as soon as you want. This is not the case with other investment products. Take shares for example, you will need sell your shares before you can access your money, and even then there may not be any one in market to buy your shares, therefore, you will not be able to withdraw your money immediately.
Still not sure if saving or investing is right for you?
Here are three questions you need to ask yourself if you are still torn between saving and investing. Get your notepad out, a pen handy and answer these three questions to get you on your way.
1. What is your purpose for investing?
It might seem an obvious question but let’s look at it closely to help you define exactly what you want to achieve.
Life doesn’t always go to plan and the COVID-19 pandemic has demonstrated that in an extreme manner. Do you have a cash reserve to provide for your living expenses and lifestyle? A good rule of thumb is an amount equal to six months of your net household income. If you are yet to reach this, you should continue saving.
Generally, the concept of saving implies that you have an intention to spend the money, likely in the short to medium term (between now to three years). So, is the money you’re putting aside, required for a purpose that you must fulfill (e.g. children’s education) or a purchase you do not want to forgo (e.g. a home)? If it is for a specific purpose in the short to medium term, you should continue saving.
Investments can have varying characteristics, for example a stable balance, income generation, the opportunity for growth. Your purpose will determine what you need from your investments. It is important to have a sound understanding of both your savings and investments, as things are not always what they appear on the surface.
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2. What is your investment timeframe?
Right, so we have a purpose but when are we going to do something about it?
People generally refer to guaranteed cash money in the bank as savings. Investments on the other hand fluctuate in value. For this reason, even conservative investments like fixed interest, have a minimum suggested timeframe of three years. For high growth investments, maybe property or shares, the suggested timeframe increases to five – seven years. These timeframes work on a reasonable probability that your investment will be higher after that time than when it commenced – however, even this is not likely during periods of significant market volatility.
Outside of a fixed term deposit, your savings in the bank are generally immediately accessible to you whenever you require them. Other investments may take time to withdraw or sell (think here of physical property). Even investments that appear to provide immediate withdrawal can sometimes be restricted in certain market conditions.
For example, during the global financial crisis several fixed interest investments ‘froze’ withdrawals, restricting access to money for a period of time. If you can’t accept any variability when accessing your money, you should continue saving.
When is the right time to invest? Given investments do fluctuate in value and the period for investment is long, some people adopt an approach called dollar-cost-averaging. Rather than investing all of their money at once, they make numerous smaller periodic investments with the aim of getting an average purchase price over time. However, this option is not possible with all investments.
3. What is your appetite for risk?
And, we’ve saved the hardest for last. How do you ensure you sleep well at night with the decisions that you have made?
Will you meet your goal without the need for investing? Any investment contains various types of risks which ultimately means there’s a real possibility it may decrease in value, even to zero. If you’ll reach your savings goal for its purpose without taking any risks beyond inflation, do you need to invest?
Various factors impact the value of an investment, like interest rates, economic outlook, business performance, inflation – these are referred to as risks. Your willingness to accept these risks and the impact they have on the value of your investment is referred to as your risk tolerance. How much risk are you are willing to accept without being anxious and meet your purpose? How much of your investment could you afford to lose? Your response to these questions will influence your decision to either keep saving or invest.
Following on from this, most people experience a greater negative emotion when they experience loss. Further, there are various personal biases that may influence our investment decisions and behaviour, including overestimating our risk tolerance. Tools are available to help you understand what you need from your investment and how you feel about risk and volatility.
Related articles: 4 Financial Risks investors should be aware of
So, should you start investing or keep saving?
Your purpose is the primary consideration in deciding whether to keep saving or to explore investing. Investments provide different outcomes and these must align to your purpose.
Remember too, that only with the minimum suggested timeframe and access requirements, will investing be appropriate for you and your tolerance toward risk and volatility will influence what investments may be suitable.
If you are not certain about any of the above, professional financial advice is the best way to navigate your purpose and the available options.
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This article was reviewed by our Content Producer Isabella Shoard and Content Producer Marissa Hayden before it was updated, as part of our fact-checking process.
- What is saving?
- What is investing?
- What is the difference between saving and investing?
- Still not sure if saving or investing is right for you?
- 1. What is your purpose for investing?
- 2. What is your investment timeframe?
- 3. What is your appetite for risk?
- So, should you start investing or keep saving?
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