It’s easy to think of ‘saving’ as investing. While the two often go hand in hand, they also work quite differently.
On a practical level, saving involves putting aside money today for use in the future. It’s what economists describe as ‘forgone consumption’. In other words, rather than spending all your money, you tip some into a savings account for another time.
Savings is a sensible starting point in investing because it provides the funds you need to purchase a range of different assets. However investing goes one step further, helping you achieve personal goals with three significant benefits.
While saving means setting aside part of today’s money for tomorrow, investing means putting your money to work to potentially earn a better return over the longer term. Different classes of investment assets – cash, fixed interest, property and shares – typically generate different levels of return (which is relative to the risk of the investment).
Compare these historical returns over the past 30 years. As you can see…
‘Growth’ assets, such as shares and property, have historically had the best overall returns of all asset classes but have also had bigger peaks and troughs. As an investor, there is the potential to earn capital growth over the longer term as well as an ongoing income return (like dividends from shares or rent from a property).
‘Defensive’ assets, like fixed income and cash, may not have generated the same level of returns over time as growth assets but these returns have been less variable, with smaller peaks and troughs.
Inflation is the ongoing rise in the cost of living over time, and it can impact on our financial wellbeing.
One way to help outpace inflation - and generate positive ‘real’ returns over the longer term - is by investing in assets that are not just capable of delivering higher income returns but also offer the potential for capital growth.
It is possible to earn extra income by investing in quality investments.
The return on your investments might be used as a source of regular extra income for day-to-day living. Or you might choose to reinvest the money to further grow (or compound) your wealth.
The bottom line is that savings are important. Depending on your appetite for risk the benefits of investing can mean having more than some ‘rainy day’ cash.
Next: Set some goals