Saving and Investing – What’s the Difference?

20/12/2013

Well done! You have your expenses under control; you have saved an emergency fund and you have provided yourself and your family with sufficient insurance should something unexpected happen. You are now ready to start saving, or is it investing? What’s the difference?

Well if you have an emergency fund, you will have already saved some money, so you’ll understand that. Generally, saving is considered to be relatively short term and in liquid assets like cash in a bank account. Investing is a longer term commitment, usually this involves investing in what is known as ‘risk’ assets. These are assets that rise and fall in value like property, shares (equities) and bonds (corporate and government debt.) There are other asset classes such as commodities (e.g. oil and gold) but generally they do not form a large part of most investor’s portfolios.

Why do people invest in these ‘risk assets’? There are a number of reasons for putting a bit by for the future (retirement, education expenses, financial security etc.) but one of the biggest risks of putting money by is the risk of inflation eating away at the value of your money. After all, if you knew that you would be able to buy less with your money tomorrow than you can today, you would probably spend it all today.

Over the long term (5 years or more) risk assets have generally generated returns in excess of inflation whereas cash tends to keep track with inflation at best. At present, cash in most major currencies is paying a rate lower than inflation, which means that people holding cash are losing money in real terms i.e. holders of cash will be able to buy more today with their money than if they wait to spend it in the future. These negative real interest rates have forced savers to become investors in an effort to maintain the value of their money.

So what is the right asset to invest in and how can you do this cost effectively? That’s a big subject and huge investment companies spend millions of dollars every year in research trying to determine what the best asset will be for the next year. And what was the result of the research? Next week’s post will tell you some of what they have learnt.