Everyone who wants to grow their money has grappled with the question. Saving versus investing – which is best?
There’s no one right answer, but there are a few things it can be helpful to consider. When deciding whether to save or invest, here are the questions you need to ask yourself.
In the opening chapter of our ‘Investing for beginners’ video series, Dan Coatsworth details several benefits of investing, including capital growth, dividends and beating inflation.
Hello. My name is Dan Coatsworth and I’m one of the investment experts at AJ Bell.
Over a series of short videos, we will give some tips on why should you invest.
Whether you’re looking to build up enough to fund a house deposit, pay for your wedding, put your children through university or even support your retirement, investing can be a rewarding experience for so many people.
We’ve all got different reasons why people invest, but the journey we take can be similar. It involves picking a suitable investment account, identifying the types of investments that match your risk appetite and time frame, and knowing how to build and manage a portfolio.
I’ll go through all those points in this video series, so sit back and let me guide you on your investment journey.
A lot of people ask me: "Why should I invest? Isn’t it easier just to park your cash in the bank and collect interest on your savings?"
That’s a fair point and there is certainly merit in having some of your money held in cash. But the important thing to consider about investing is that you’ve got two sets of opportunities to grow your money, and potentially by a greater amount than you could get from investing in cash.
First is achieving capital growth. This means the value of your shares, funds or bonds increases over time. When you come to sell your investment, you would make a profit if those shares, funds or bonds were worth more when you exit than when you bought them. Just remember that investments can go down in value as well as go up.
The second way to make money from investing is through dividends. Companies or funds often pay out dividends two, three or four times a year. The beauty of dividends compared to interest on cash savings is that dividends often get bigger each year. In comparison, cash rates will stay the same on fixed-rate accounts. Many companies or funds have an unbroken record of growing their dividends every year, going back 50 years or more.
Some people like to reinvest that dividend money to buy more shares. So, the next time a company or fund pays out dividends, they should get even more money - if you keep repeating the reinvestment cycle, you benefit from a fantastic phenomenon called compounding.
If that’s not enough to convince you why to invest, there is a third and often underappreciated reason - and that’s to give you a better chance of beating inflation, which is the increase in the price of goods and services over time.
For example, if you’re getting 3% return on cash in the bank and inflation is at 5%, then your money will buy less in the future than it can today. But if you are making a 7% return on shares and inflation is at 5%, you’re still growing the value of your money in real terms.
Let me give you some interesting stats to illustrate what you’ve been able to get from investing versus cash in the past. While there is no way of guaranteeing this trend will continue in the future, it is worth a closer look.
Barclays has compared the returns from UK shares with other asset classes and then adjusted the figures to account for inflation. Between the start of 2003 and the end of 2022, UK shares have returned +3.8% on average, whereas cash returned -1.8% a year.
Remember these figures take inflation into account, so they’re called real returns. They imply that over the 20 years to the end of 2022, money invested in UK shares grew by more than the rate of inflation, but cash lagged behind.
This hasn’t always been the case. Over 50 years to the end of 2022, you would have got a 0.7% real return on cash - but UK shares would have still beaten cash, returning 4.5% on average each year after accounting for inflation.
In the next video, we will discuss the concept of investment goals. If you have a good idea why you want to build up a pot of money, it can really help to incentivise you to invest as much as possible. Until then, thanks for watching our tips on why to invest.
What’s the difference between saving and investing?
Whether you save or invest, you’re putting money away for your future. To decide between saving vs investing, you need to think about risks, rewards, and when and for what purpose you plan to use your money.
Saving means putting your money in cash – often an easy-access account. It means you’ll have instant access to the money, and you know it won’t fall in value. If you put in £100, you won’t get less than £100 back. You’ll earn interest, too, meaning the interest can help your money to grow.
Investing means buying funds, shares or bonds on the investment markets. Over the longer term, investing usually (but not always) grows your money by more than if you’d left it in cash. But those higher potential rewards also mean higher potential risks. Your investments could fall in value and might take a long time to recover – so you’ll need to have patience, and take care not to invest money you think you might need in the short term.
Is it better to invest or save your money?
Usually the answer to this is: both. First, you’ll want to keep some money in cash that you can access in an emergency – if you had an unexpected bill or lost your job, for example. You don’t want that money exposed to investment markets, as it might drop at just the time you need to take it out.
Likewise, any money you know you’ll need in the short term should be saved in cash, rather than invested. That’s because generally you only want to invest money you know you won’t need access to in the next five years or more. It’ll give you time to hopefully ride out the ups and downs of investment markets.
Another reason to choose saving versus investing is if you don’t want to take a risk with any of your money. Risk appetites differ from person to person, but if you know that seeing your pot of money fall in value would have a big impact on your life, or your plans for the future, you might want to stick with cash and not take the risk of investing.
But if you want to achieve a potentially higher return from some of your money, and know you won’t need it for at least five years, then investing could be the right way to go.
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What are the main differences between saving and investing?
- The first main difference of saving vs investing is that cash usually generates a lower return over the long term. If we look back at cash returns vs investing returns, investments have always outperformed cash over longer periods. So by investing you’ll probably generate more money for your future self.
- The second difference to consider when deciding whether to save or invest is inflation. Cash savings will rarely beat inflation, which means the spending power of your money gets eroded year after year. For example, if a chocolate bar costs £1 today and you have £100, you can buy 100 chocolate bars. But if inflation is 10%, in a year’s time that chocolate bar will cost £1.10. If you still have £100, you’ll only be able to buy 90 chocolate bars. Because investing offers higher returns, it gives your savings a better chance of beating inflation, even in times when inflation is higher.
- The third big difference between saving and investing is risk. Although inflation can eat into the value of savings over the long term, the cash itself is protected by the Financial Services Compensation Scheme (FSCS) if a UK bank or building society fails. The FSCS protects up to £120,000 per person, per banking license.
Although investing has the best chance of beating inflation and growing your money over the long term, this is not guaranteed, and you could get back less than you originally invested. The FSCS can also step in (up to £85,000 per person) if an investment fund provider fails and is unable to meet claims against it. However, this is not a protection for the value of your investment if a fund performs poorly. In this instance, you can still lose some money through the value of your investment. You’ll find further information about compensation arrangements on the FSCS website.
When investing, of course, the value of your investments can fall as well as rise, so you could see the value of your money reduced. However, remember inflation. If cash interest rates are below the rate of inflation, the real-terms value of your will erode over time. With investing that risk is reduced. So it’s a balancing act. - Finally, the fourth difference when weighing up saving vs investing is your time horizon. Saving is often a good option in the short term. But over the long term, the combination of low returns and inflation can eat into your savings’ value. By contrast, investing is good for the long term but isn’t a great idea for money you know you need in the short term (i.e. the next five years).
How can I grow my money?
As we’ve discussed above, the best way to grow your money over the longer term – by more than inflation – is to invest it. However, whether you save or invest you still want to maximise your returns.
If you go down the savings route, that means finding the best interest rate you can get. Just remember, it’s important to make sure you choose a savings account with a reputable bank that’s authorised by the Financial Conduct Authority and covered by the FSCS.
Head over to our Cash savings hub where we've collected some of the best interest rates in the market, and all of our accounts are protected by the Financial Services Compensation Scheme (FSCS) covering up to £120,000 per bank.
All of our investment accounts are also covered by the FSCS scheme, so they're protected if anything goes wrong with the company that is holding your assets. If you decide to invest, you’ll want to pick investments that offer the best balance between returns on the one hand, and risks on the other. It can be tricky – but you can get a little help, or a lot, by picking one of our investment ideas.
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Important information: How you're taxed will depend on your circumstances, and tax rules can change. Remember that the value of investments can change, and you could lose money as well as make it. These articles are for information purposes only and are not a personal recommendation or advice.