Even though both saving and investing money means trying to grow your wealth, there are differences between these two terms.
While saving means adding money to your savings account and earn money through interest, investing includes committing money into a certain investment in order to try to get return much higher than that in cash. Also, they carry different risks with them, together with different opportunities to make more money.
If you need to decide which one to opt for, it’s important to be aware a couple of factors and your financial situation. Here’s a quick guide.
Should you save and how?
The quickest question would be – yes, everybody should have an emergency savings fund. You need to start setting up an emergency fund that could keep you for three months in case you lose your job and other financial sources. This means you need to be able to pay your rent, food and everyday essentials for three months. In essence, everybody needs to work on financial security in case something goes really wrong.
Once you have built up your emergency fund, it would be good to set aside at least 10% of your monthly income (or as much as you can). The best method is to set a goal like saving up for a new car or a holiday – it will be a strong motivation.
The only situation in which you shouldn’t save is when you have, for example, debts to pay.
Most important saving terms
Interest is the most important term when saving – it is the payment you receive when you deposit your money. Usually, it’s expressed as AER (annual equivalent rate) so that you are able to compare different savings accounts. When you earn interest, it becomes your returns.
Should you invest and how?
Investing is a decision made according to your goals. If you have short-term goals (within 5 years), the easiest thing is to save up because the stock market may experience big changes during that time, resulting in you having a loss. Having medium-term goals (5-10 years) means you’ll have to decide how much risk you are willing to take. If you are flexible, you may invest a certain amount of money to get a bigger return that you would get by saving money for the same period. Longer-term goals (more than 10 years) may motivate you to invest because inflation could affect the value of your savings. When looking at longer terms, the stock market holds a better position. It’s even possible to reduce the risk if you invest in different investment types.
Types of investment
There are many types, but let’s just stick to the most frequent ones:
stocks and bonds – by investing in stocks, you can earn from the company’s success if the stocks’ value and dividends rise. With bonds, you loan money to a company and get periodic interest payment, along with the return of the bond’s principal sum.
mutual funds – a pooled investment vehicle that enables you to invest in various ways in the offered vehicles (stocks, bonds or anything else)
alternative investments – the usual ones are real estate and diamond investments. While real estate investment means buying a commercial or residential property and then reselling it after an upgrade, diamond investments refer to buying diamonds of different types, monitoring their rise, deciding whether to have mounted or loose ones and selling them in the right moment to the right buyer.
Most important investment terms
Asset classes refer to different types of investment, including stocks, bonds and commodities like gold.
Compound interest is, in other words, interest on interest, meaning you earn on your invested capital, as well as on the interested accumulated over the period.
Diversification is a good method of reducing risk by spreading money on different investments and geographical areas.
Saving and investing money are both effective ways of making more money for a certain goal. The secret is in knowing when to opt for one of them and be sure you are making the right choice according to your situation.