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What’s the difference between saving and investing?
It’s easy to confuse saving and investing. Although the goal of both activities is to grow your wealth, saving and investing are quite different.
Saving involves putting cash into a savings account and (hopefully) adding to it regularly. Your capital is not at risk and you have the chance to grow your money by earning interest. However, there is also the chance that the rate of interest paid on your money may not be higher than the rate of inflation – so your money could be worth less in real terms.
“It’s important to understand the jargon used when talking about saving and investing”
Investing involves committing money for a longer period of time into an investment vehicle in the hope of making greater returns than those offered by cash. Unlike saving, investing involves an element of risk and there is no guarantee you will get all your initial capital back, let alone make a profit. But on the other hand, you could grow your wealth, depending on how your investments perform.
It’s important to understand the jargon used when talking about saving and investing. Here are some of the most common terms.
Different types of investments are known as asset classes. The most popular asset classes are cash, property, shares and bonds. Other asset classes include commodities (such as gold and oil), foreign currency, art and peer-to-peer lending. The various assets owned by an investor are known as an “investment portfolio”.
A bond is a debt security, similar to an IOU, which can be traded in the financial markets. Borrowers, including governments or corporations, issue bonds to raise money from investors willing to lend them money. The money is repaid with interest after a set period. In the UK, government bonds are referred to as “gilt-edged securities” or gilts.
This basically means “interest on interest”: you earn interest on both the capital originally
invested and on the interest accumulated in previous periods.
You can reduce risk be diversifying your investment portfolio. This means spreading your money between different asset classes or geographical regions. Diversifying helps spread
the risk of your portfolio under-performing or losing money over the long term.
Investment funds are collective investment schemes which pool your money with other investors to give you a stake in a ready-made portfolio. Unit trusts and open ended investment companies (OEIC’s) are both types of investment fund. Funds offer a practical and affordable way to invest in different shares and other asset classes while spreading the risk and sharing the cost of setting up the investments with other investors. The success of this type of investment depends partly on the expertise of the fund manager.
Interest is the payment received for depositing your money (when you save, the bank in effect borrows your money). Interest on savings is typically expressed as annual equivalent rate (AER) so that you can easily compare savings accounts. You earn interest on savings and pay interest on debt.
Returns are the money you earn from your savings or investments. The type of return depends on where you put your money. If you save cash, the interest you earn will be the return.
For investments, returns may be “income” (for example, share dividends or rent from a property) or “capital gains” (the difference between the price you paid for the asset and the price you sell for).
Investment returns are not guaranteed. This means there is an element of risk when you invest money. For example, you may buy shares only to see the share price fall.
Some investments involve a high degree of risk but also the potential for greater returns.
How much risk you should take depends on your personal attitude to risk, your investment goals and time frame, your need for returns and your capacity for loss.
A share is simply part ownership of a business. A company can raise money to finance its business by selling shares to investors. If shares are sold to the general public, the company will be listed on a stock exchange such as the FTSE. The alternative is to have successful saving techniques.
From compound interest to focusing on your long-term goals, saving for your future can seem confusing.
The information and any opinions expressed in this article should not be taken as financial advice. The value of investments can go down as well as up, and you could get back less than you paid in. You may wish to consult a professional financial adviser before making investments, please note they may charge a fee.