What is the difference between savings and investments?
Savings and investments are terms regularly used when creating financial plans. They are two unique products, so it’s important to understand the differences between them and how they work as a combination to achieve your financial goals.
Savings, by definition, involves the protection and preservation of money from loss. This is either through spending it or in more risky financial products.
Saving is a way of putting money aside for the future. It is not a way of making substantial income, but a safer solution to short term needs. Savings are useful for building up a deposit for a property or paying for one-off events.
As a general rule, your savings should be sufficient to cover all of your personal expenses for at least three months. This is known as an emergency fund. If you experience any financial changes in your life you will have sufficient time to adjust accordingly without adding undue pressure. Any specific purpose that may require cash in five years or less will typically be savings driven.
How much you have saved will define how safe your savings are with UK banks. Up to £75,000 of savings is protected by the Financial Services Compensation Scheme per person per firm in the UK.
Making investments typically means a longer-term commitment on the anticipation of growing more than through savings. However, capital is likely to be at risk and with many investments, there is a risk that you might not get back what you invested in the first place. Risk includes occasional and inevitable downturns in the market. However, over the long-term (five years or more) those dips have historically smoothed out into an overall upward growth pattern.
For instance, investing in FTSE 100 funds through a stocks and shares ISA is generally considered to be good long-term (greater than five years) investment option. For the past 70 years since World War II they have been on a steady upward curve . However, over the short term they can be volatile as they can experience short term drops in value.
Although assuming a high level of risk for a short investing horizon is not appropriate, neither is simply storing your cash in a low-interest-bearing deposit account. The goal is to find a way to ensure that your money is safe from risk and readily available for near-term use while at the same time positioned to offset the eroding effects of inflation.
The risk of inflation is likely to be particularly relevant in the near future due to the weakness of the pound and the amount of consumer goods that the UK imports. This means keeping all of your savings in cash may not be the ‘risk-free’ solution it’s sometimes assumed to be. If the returns you get on your money are unable to at least match inflation, then your money will effectively be losing value each year. The low rates offered on savings accounts combined with rising inflation since the EU referendum mean this scenario is more likely than in the recent past.