Saving vs Investing: an important difference

People often use the terms saving and investing as though they are synonymous. However, while the two terms are related, they are not the same thing. There are important differences between saving and investing, and it pays to be aware of them.

SAVING

At its core, saving is keeping some surplus income in a safe place, to spend later. This could be anything from stashing some cash under your mattress, to opening a bank account or ISA.

Saving accounts are risk-free and come with the opportunity to increase your capital through interest. However, this interest rate is not always higher than the rate of inflation, so in real terms, your capital is not guaranteed to increase in value.

INVESTING

Investing involves an element of risk. Investors place their money in stocks, bonds, trusts or property, amongst other things, with the hope that they will make a financial gain on their investments. However, there is no guarantee that they will make any gain, or that they will even get the value of their initial investment back. Their money could grow, or it could vanish.

Investments often involve committing money for a longer period than saving. It may involve the pursuit of long-term financial goals rather than a short-term capital boost.

INTEREST RATES

The decision of whether to save or invest can sometimes come down to interest rates. If interest rates are high, saving becomes an attractive option as you assume no risk and are guaranteed to increase your capital year-on-year, hopefully at a higher rate than inflation is eating into it.

If interest rates are low, saving becomes less attractive as it might not keep up with inflation. In these circumstances, many people prefer to invest. The cost of borrowing decreases, and it makes more sense to invest than save.

CONFIDENCE

Another factor people consider when choosing whether to save or invest is confidence in the economic climate. After the financial crisis of 2008, low investor confidence meant that many people began saving their money rather than investing. They had little confidence in the markets and were not willing to take financial risks at that time. As a result, interest rates came down as more people began saving and fewer people were investing.

When confidence is higher, investors are more willing to take a risk and investment increases. When investment increases across the board, interest rates begin to rise as banks seek to capitalise on increased investor borrowing.

This means that, in theory, saving and investing are linked. As more people invest, interest rates rise, causing more people to save, then as more people save, interest rates decrease, kickstarting investment again.

Both saving and investing are essential methods of improving your financial capital, and successful investors and savers will often use both methods to get the most out of their capital and secure their long-term financial stability.