For many people, the difference between saving and investing is the difference between putting regular amounts of money aside each month and having to deal with a large capital sum. But for professional financial advisers, it also relates to the type of investments you choose for your money.
Savings are another term for cash deposits while investments describe shares, property and other assets that are riskier and have the potential to produce capital growth. Ideally, you will own a mixture of both, but your choices will be influenced by factors such as your attitude to risk and your time horizons.
Everybody needs some savings — Money in a bank or building society account that is easily accessible. This is the cushion you need to cover unexpected bills, such as a new washing machine, for extra spending when necessary, and for general emergencies. It means you are not forced into cashing in longer-term investments at the wrong time.
Some people prefer to keep all or most of their money in cash deposits. If your savings are modest, this is understandable because deposits give you capital security. If you put in £100 you will get back £100 either on demand or at the end of the term agreed, unless the savings institution goes bust. Fortunately, nowadays UK banks are covered by a deposit protection scheme. This means you will get back all your money for deposits of up to £75,000.
Deposits may earn a variable or fixed rate of interest. New accounts are always being launched and some pay temporary bonuses, so you need to be on your toes to get the best rates.
The risk with cash deposits is that the interest you receive after tax does not necessarily make up for the impact of inflation – The effect of rising prices which gradually erodes the purchasing power (the ‘real’ value) — on your savings.
Investments are places to keep money that you do not intend to withdraw for at least five to ten years, either because you are building up your capital or you intend to use it to generate income. Investments normally involve some risk to your capital, but also the prospect of better returns than you can expect from cash deposits.
Broadly speaking, there are four different types of investments – cash & bonds, property, shares (equity) and a catch-all known as ‘alternatives’. See a Guide to investments for more detail.
Many people believe some risk is worth taking with investments that will help to protect the real value of their capital against inflation over longer periods. Risk of loss can be minimised using funds that spread risk across many shares or other investments. Combining different types of investments also helps to reduce risk.