Saving vs Investing: What’s the difference?
People often use the terms interchangeably, but there’s a world of difference between saving and investing. Here’s a look at what those differences are, and how you can use both approaches to achieve your short-, medium- and long-term financial goals.
There are three things you can do with your money. You can spend it, save it, or invest it. It’s really as simple as that. There are, however, different ways of doing all three – and the differences between the last two (saving and investing) are where things can get confusing.
Spending is relatively easy to understand, if only because we tend to do so much of it! Spending (or consumption, as it’s also known) is the final sale of goods and/or services. You buy something, then either own it or use it up. Saving, meanwhile, is the opposite. Saving (or deferred consumption) refers to income that is not spent. There are various ways of doing this, ranging from putting your money in a deposit account at the bank, to hiding it in a sock under your bed. Finally, investment is when you spend your income on something that promises to create future returns. It’s a big difference - while saving is relatively passive, investment puts your money to work. But that’s not the only difference.
In most cases, saving is for small, short-term goals. You might save up for a new fridge, or for a scooter – usually with the aim of spending that money on that goal within the next two years at most. In most cases, you’ll put your savings into a bank account, where it will earn a small amount of interest at very low risk. Investing, on the other hand, is best for bigger, longer-term goals. You might invest for your retirement, or for your child’s (or your own!) education – usually with your eye on a goal that’s at least three or more years away.
The time factor is very important, because investment returns depend on financial markets which can be quite volatile in the short term, but provide good returns over the long term. To see how investing with Prudential can help you achieve your medium- or long-term goals, use our Goal Calculator.
Liquidity is another big difference between saving and investing. This refers to how easily and how quickly you can access the money. If you’re saving money in a bank account, you should be able to withdraw it within a few minutes, or a day or so at most. Other fixed-term bank deposits may offer higher interest, but you will probably have to wait several months to access them, or you might even have to pay a penalty if you want access right away. Investing directly in unit trusts is different – they offer the opportunity for higher returns with easy access – usually within three days.
Of course if you are investing towards retirement in a retirement annuity, your money won’t be available until you reach 55. Also, if you are contributing towards your company’s retirement fund it makes sense to consider that money inaccessible until your retirement as well, although it will be paid out to you if you leave the company.
Saving has a relatively low risk of loss of funds. Let’s take the extreme example of the cash stashed under your bed: here, you’re unlikely to lose the money… much like if you were to save it in a bank. In both cases, the money’s not at much risk at all. When you invest, however, you do carry a risk of loss. Hopefully your money will grow and produce healthy investment returns, but the truth is, there’s no guarantee. Remember, financial markets move up and down, driving the value of your investments, but the good news is that the risk of loss falls markedly over time. So the longer you stay invested, the more likely you are to grow your investments to meet your goals.
The low risk of savings comes with a trade-off, though. The R100 note you hid under your bed yesterday will still be a R100 note when you dig it out again in five years’ time. That same R100 will then buy less because of inflation. So when you don’t earn interest or returns above the rate of inflation (generally accepted as around 6.0% in South Africa), you’re actually eroding the value of your savings. This is a risk of not investing, or of earning only very low interest. While investing does carry risk, this can be reduced by time in the market, and by diversification.
So while the words ‘saving’ and ‘investing’ are sometimes used interchangeably, they are quite different – and each has its own role to play in your overall wealth strategy. The smart money is on both, enjoying the benefits of both saving (for the short term) and investing (for the longer term), in a holistic financial plan. Speak to your financial adviser about the best way to make both work for you.
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