If you put cash into a savings account then you can be fairly certain you’ll get all of it back. You’ll also be paid interest at an agreed rate, although if the rate of inflation is higher than this then your money will be losing value in real terms.
Invest your money, by contrast, and you’ll give yourself the chance to earn much higher returns – but with the risk that you might get back less than you invested, or even nothing at all. This is why we, along with most other financial institutions, recommend you should only invest in something if you’re going to do so for at least five years. Investments such as stocks and bonds have historically been volatile over the short term – that is, their prices have tended to rise and fall sharply, without warning. However, they have tended to perform better than cash savings over the long-term.
Which to pick?
Before you start planning for the long term, you should build up enough cash savings to cover your essential outgoings for at least three months. With this emergency fund in place, you can start planning for the sorts of life goals that we explore in detail elsewhere on this site.
Once you’ve done that, the choice of whether to save or invest therefore boils down to one simple question: how soon will you need the money that you’re trying to raise?
If you’ve got a major expense coming up within the next few years such as a wedding then you should aim to hold the money you’ll need in a cash savings account. This way, you’ll avoid the risk of having too little cash on hand to pay the bill when it becomes due.
If, on the other hand, you’ve got more than enough money to cover your short-term expenses, you may wish to put the surplus into an investment account. By doing so, you’ll give this money the chance – though not the guarantee – of generating higher returns than would be possible elsewhere.
A growing family is both a short- and a long-term goal. You’ll need plenty of cash saved in the run-up to your baby’s arrival but, for expenses that are more distant, you may wish to start investing right away. Indeed, if you’re planning on educating the kids at a private school then investing could be the only way to give yourself the chance of affording your first-choice institution. Also bear in mind if your family is growing, you will need to make sure that your emergency savings fund is still big enough to cover the needs of extra children.
Meanwhile, preparing for retirement often means investing all your working life, usually through a pension.
Striking the right balance
Different plans involve different timescales, so you’ll probably want to save and invest simultaneously throughout your lifetime. And in order to get the balance right, you’ll need to review your strategy regularly and adjust it as your needs change.
The number of things that need to be considered can seem daunting so you may wish to speak to a financial adviser. They can help you to balance your savings and investments so that you end up with a level of risk and potential reward that you find comfortable. At the same time, they can make sure you don’t pay any more tax than you need to. If you don’t yet have a financial adviser but are interested in finding one then you can find out more here.