It might seem like stating the obvious to say there are fundamental differences between saving and investing, but do you actually know what those differences are and how they can impact your financial planning?
By definition, saving refers to the practice of setting money aside, usually on a regular basis, to accumulate toward a specific goal, such as a holiday, a home deposit, a car, or perhaps some other less concrete “rainy day” purpose.
Investing, on the other hand, is the practice of putting your money in some type of asset or account with the purpose of growing value through returns or capital growth.
Where do you save or invest?
The priority with saving is preservation and accessibility, so the vehicle used is normally one which protects your money until it can be applied to the intended purpose. In years gone by this may have meant hiding cash in your sock drawer or putting it in a safe, but these days most of us use a bank account. It may only be earning minimal interest, but the main purpose is simply to keep it secure and easy to access.
Investing is focused more on growth or income generation, so the priority is usually to find a vehicle that can deliver those attributes, such as shares, property, or some kind of deposit product that pays interest. This will usually involve limited accessibility and may also involve increased risk of values fluctuating over time.
Should you be saving or investing?
The short answer for most people is “both”, but the degree to which you do either is heavily dependent on your situation.
If, for example, you are living from pay packet to pay packet without any fallback funds, or if you have significant debts which are out of control, then saving takes on a much greater priority.
As a general rule, if you are in that type of situation, you should first focus on:
- Saving to build up an emergency fund amounting to at least three months’ income
- Directing any other discretionary income toward debt repayment until you have debts under control
- Ensure that you have contingency plans in place to protect dependents against disasters, such as illness, accident, or premature death. This can be done via personal insurance plans, such as income protection and life insurance.
These actions will provide stability within your financial planning and once they are sufficiently catered for, you can then start to invest.
Once you are in a position to invest, the next step is to ensure you have a clear picture of your goals and timeframes. Generally, investment goals can be categorised into short, medium, or long-term, and the way that you invest will be heavily dependent on which of these categories your investment goals fall into.
Matching investment types to your goals
Due to the fact that most investing involves some degree of risk, it is important to match the type of investment to the goal you have in mind.
Short-term investment goals might include anything that is up to five years away, for example, if you are aiming to build up an education fund for a child or grandchild, and you know they will be going to university in five years’ time, then you need to invest in something that you can confidently liquidate in five years without undue risk of losing capital. This might mean primarily investing in cash-based assets such as term deposits or fixed interest investments.
If you were to invest in property or shares for such a short term, there would be a real risk that the market may be depressed at the time you want to withdraw, so these would not be wise investment choices.
For medium and long-term goals, however, you have more scope to invest in those more volatile asset classes, because historically, they have a better chance of providing real growth over time.
A classic example of this is your superannuation. If you have 10 or more years before you need to access the funds for retirement, then you have a substantial timeframe in which to diversify your investment across a variety of assets, including property, shares, and managed funds. Because you don’t have a need to liquidate those investments early, you can ride out any fluctuations with the objective of capturing growth over the full timeframe of the investment.
As you get closer to the end of the timeframe, you can gradually switch your investment out of growth assets and into more secure areas, so that you can lock in any of the gains you have made.
Get help to put your strategy together
Most of us have a range of things that we might be saving or investing for. This can often mean we need a sophisticated approach to where we allocate funds to gain maximum effect.
A financial planner can be invaluable in helping you identify and rationalise all of your short, medium and long-term goals, and can help you map out a strategy that will allocate, manage, monitor, and adjust your strategy over time.
What are your ideas on the best ways to save? Share your thoughts below.