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Investing Basics Series: The Difference Between Saving and Investing
In this ‘Investing Basics’ Series, rather than jumping in at the deep end, I am focusing on simple topics and generating discussion around them, to help frame an understanding of WHY investing is so important.
Today I am talking about the difference between saving and investing.
Save for retirement
Invest for your child’s education
We hear similar messages all around us. The words ‘saving’ and ‘investing’ are often used interchangeably, yet frequently in the wrong context. (Hint, the above statements don’t reflect the right use for money in each context!) Whilst saving and investing are related, there is an IMPORTANT difference between them.
What is Saving?
Saving money means putting it away with the intention that it will be spent on something at a future date. What is important here is that the money itself is intended to be spent i.e. it will flow out of your life at some point.
Examples of things which we save for may include:
- A wedding
- A deposit for a house
- A meaningful emergency fund
- University fees for our children
- A car
- Christmas fund to cover presents and parties
In the context of a financial plan, the things which we ‘save’ for are typically, although not exclusively, short and medium term goals
When we have a savings goal, we know that we will need a defined amount of money to achieve that goal e.g. £50,000 for a house deposit. We typically don’t want to risk the amount we’ve put in being lower when we come to need the money in the future. We also want the money somewhere where we can access it relatively easily when we want to use it. Savings may be held in:
- Current accounts
- Savings accounts
- Premium bonds
- Term deposit accounts
- A biscuit tin!
Depending on which savings vehicle you choose, you may or may not earn interest on your savings. However, you do have a high level of certainty of the amount which you will have when you want to use the money for your savings goal.
What is Investing?
By contrast, money which we invest is not intended to flow out of our lives. Instead, it is used to buy assets with the desire that they will result in financial gain, and an inflow of money in to our lives.
An asset is a source of future economic benefit.
Although it is what it is, this quote is a bit dull. I prefer to think of assets as things which will feed me even if I am not working, make me money while I am sleeping. You see where I am going?
Assets WORK for us to earn more money for us. Examples of such assets are:
- Stocks and shares
- Low-input businesses
- Property
When we talk about financial gain, we assume that the assets we invest in will generate more money for us in the form of capital growth (i.e. what they are worth will increase), income or both.
In contrast to saving, where our money is tucked away relatively safely, there is an inherent risk associated with investing in an asset. The future value of that asset is unknown.
Investing involves an element of risk, and there is no guarantee that you will get back the money which you initially invested
Investing isn’t suitable for short term goals where a fixed amount of money is required with a degree of certainty, as the returns can be volatile. This means that the underlying value of the asset in which you have invested can go up and down over time.
Instead, investing is associated with long-term wealth generation.
A Butterfly Garden
I read a beautiful analogy recently but can’t remember where to give credit to whoever used it. So I can’t take credit for this but think it describes saving and investing perfectly!
Imagine you want butterflies (read: money) in your life.
You could take a net out to different fields each day and catch them. You are successful at catching them and you spend time reading up on how best to catch them. You even get to a point that you buy a bigger net.
But the reality is that a) you always need to physically be involved in catching the butterflies, and b) when you catch too many, you can’t keep hold of them very well in your net.
You also live in fear that maybe one day there will be no butterflies to catch.
Or…
You could forget about a net. You could plant your own garden around you, an amazing incredible garden which attracts the butterflies.
As time goes by, the garden becomes hardly any work for you as the insects it attracts pollinate it for you so it becomes even more appealing to the butterflies. There is no fear that they won’t be around you as they love your garden.
You wouldn’t need to worry about anyone taking your butterflies either because they are always plentiful and if they did, more would arrive in the future.
In essence, what this teaches us is that it is so important to focus on building your garden (generating wealth through assets) so that you don’t have to constantly be worrying about your net (making money).
But Should I Save Or Invest First?
I bang on all the time about why investing is important, but the simple answer is that you need to be doing both. But…. work on getting to a stage where you are prioritising investing!
Owning income-generating assets is the only way to generate long-term wealth
Start with your financial goals in mind so that you have appropriate savings goals. You absolutely need to be saving in order to have enough for those short and medium term goals so that you don’t either a) need to resort to credit to pay for them or b) end up having to sell the assets you have invested in which are making money for you.
But you need to be aware of potentially having too much money sitting in savings if you’ve exceeded your savings goals; be conscious of the impact that inflation is having on your savings.
When we invest, we can start to live off what the assets themselves earn. We are able to move away from thinking about earning money, instead thinking about the assets we have invested in making the money for us.
This is financial freedom.
A Mindset Shift
Investing involves a huge mindset shift for many. We are conditioned to think that we go to work to earn money to pay for the things we need in life, essentials and then luxuries. Money in, money out.
Investing creates a means to achieve the ability to not have to work for your income. It means you can enjoy the butterflies in the garden without having to constantly chase them around with a net.
Who fancies planting a butterfly garden??
Many coaching clients who come to me know that their money isn’t working hard enough for them. If you need help working through your goals and understanding the part that investing can play in addition to what you are already doing with your money, jump on a FREE discovery call with me to see how money coaching and the accountability it affords can help you.
