What’s the difference? How to decide which route is best for you.
When you are trying to build a pot of cash, the first choice you have to make is whether you will save or invest. Saving is where you simply put money in a bank account and let it accumulate. Investing is where you put your money to work in the stock, bond or property markets and take some risk in the hope of a getting a greater long-term return.
When you invest in the stock market, you are buying individual ‘shares’ of companies and in return you receive some of their profits. These may be returned to you as dividends, or the profits may be reinvested in the company to encourage future growth in revenues, and therefore the share price.
All investments involve taking a risk that you may get back less than you put in; this is why the potential rewards tend to be higher. Investing, therefore, could protect you against inflation, and hopefully give you a stronger real return, compounded over time.
Deciding on the right investment
The right investment will depend on how much risk you are willing to take. There is no one right answer to this, and it will depend on your personal circumstances. It will depend on factors such as your age, your lifestyle, your income and your personality. If any variation in the value of your investments would keep you awake at night, investing may not be for you.
However, you should consider that investing may be a necessary part of achieving your long-term goals. At the moment, the interest on many savings accounts is below the level of inflation, and therefore you may be losing money in real terms over time. In this way, savings accounts though offering security of capital, may not be as ‘safe’ as they seem.
When you have decided on your risk tolerance, you need to match it to the right type of investment. For example, in government bonds, you will get a relatively low return because the UK government, say, is unlikely to default and you should get your money back. However, when buying shares in a small company, there is a higher chance that it will go bust and you will not receive your money back, therefore to compensate for the risk your potential reward will be higher.
Investors must also take account of market conditions. Every asset class has a cycle and investors need to try and avoid buying when it is at its most expensive. The best example of this was the technology boom of . If you had bought at the top of the cycle, you would have lost a lot of money, whereas if you had invested a few months later, you would have made a good return in the following decade.
How to invest
The answer is not to try and move in and out with the ebb and flow of the market, as this can be hard to predict, but to save smaller amounts regularly. This helps even out the price at which you buy into the market. This should give you a more consistent return over time.
Let’s talk about risk
Past performance should not be seen as an indication of future performance. The value of investments and income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.
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