Saving vs Investing: which is best and when?

What’s the best way to meet your financial goals? Is it shoving as much cash as you can under the mattress? And is saving or investing a better fit for your needs?

What’s the difference between the two anyway?

Here’s your guide to saving vs investing, and a few ways you can decide which one is right for you.

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Differences and similarities between saving and investing

Saving normally means holding your money as cash, either with a bank or building society. Investing means exposing that cash to the financial markets by buying assets like company shares and bonds for the opportunity of higher returns than cash.

A lot of the time people make a quick statement about investing carrying risk and cash being safer but there’s a bit more to it than that. 

Yes, holding your savings in cash means they won’t be exposed to the ups and downs of the market, and for some people that will suit their risk tolerance. But if your interest rate is lower than the rate of inflation, the value of what you’re actually able to buy with that money is slowly eroding.

Investing does carry a higher level of risk though, as you are buying assets that have the capacity to go up and down in value, and may even lose their value entirely. You could get back less than you invest.

But that ability to change in value can also be a huge benefit as stocks rise. Long-term investors look for companies able to slowly grow their earnings over time and reinvest in themselves to increase the value of the firm, as well as pay dividends to investors. 

Risk and volatility are the price investors pay for the hopeful long-term outperformance of equities (company shares) over cash.

As interest rates have been so low since the financial crisis in 2008, this has actually been the big driver for a lot of savers to turn to investing. Not the goal of getting rich quick, just the need to make their savings at least keep up with inflation.

And it’s easy to see why these savers are climbing the risk scale into investing. The current UK base rate of interest (0.1%) is now the lowest since the Bank of England was established in 1694. It has been at that level since March 2020, having been cut in response to the economic stress of the coronavirus pandemic. 

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Pros and cons

1. Pros and cons of saving

When you’re putting money away there’s always a risk/reward balance you need to make sure matches your comfort levels.

Cash has the advantage of relative safety, meaning you can be pretty sure how much is going to be in that savings account from day to day. 

But for that security you sacrifice the opportunity to grow those savings above the rate you’re being offered by a bank or building society.

That might suit you, as investing does carry more risk in pursuit of higher reward, or it might be that you are willing to put up with that risk in order to give your money the chance to go further.

Savers need to weigh up the positives and negatives if they are to start investing.

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2. Pros and Cons of investing

Cash savings can be useful for any financial goals you have in mind in the next five years. Investing could help for goals any further out than that.

That’s because markets move up and down and the last thing you want is to go to withdraw that money when you need it, only to see the market has hit a rough patch and the value of your account is down.

Giving your investments the chance to build up that all-important compounding effect, and allowing those companies in your portfolio enough time to grow, is important. Remember, investing is for the long term.

Investors need to understand the balance between risk and growth potential.

3. Why is investing money riskier than saving money?

We should be careful when comparing long-term returns from company shares and cash. It’s not just about what that growth looks like over time, we have to take into account the risk taken to get there. A lot of investors forget to keep this side in mind but it is important and fair to acknowledge.

Investing carries more risk because the companies we invest in have the potential to perform very differently from each other. Drinks firms, mining companies, tech businesses - they all have internal and external influences that can increase or decrease their value on any given day and throughout their lives.

The fact that we ultimately can’t predict what happens to them brings in that element of risk. That doesn’t mean investing is a coin toss, far from it. Companies regular update the market on their financial performance, their plans and their outlook for the near future. Coupled with that, we can do our own research into which firms have consistent earnings growth, and products and services whose value to the world is increasing.

4. Rules of thumb when saving

1. Pay off unsecured, highest-interest debt first. This means things like credit cards where the interest involved could end up working against you. Student loans don’t fall into this bracket. They won’t affect your credit rating if you’re applying for the likes of a mortgage but they will clearly affect your overall ability to pay that mortgage. As the amount owed is written off after 25 to 30 years after the first date you were due to start repayments (depending on when you took out the loan) it’s more helpful to consider the monthly hit to your spending as a kind of graduate tax.‍
2. Pay your future self. As soon as you get paid, put some money away. Saving first, rather than last, makes it a priority and means you’re much more likely to save money, not spend it.‍
3. The 50/30/20 rule. A useful way to think about how much to save is to keep 50% of your income for necessities, like housing and bills, 30% for your lifestyle, like eating out, and 20% for financial goals, like saving for retirement. It’s a broad rule of thumb that you can manipulate to suit aggressive savings targets or other commitments but is useful as a starting point.‍
4. Save for multiple goals. Save for short, medium and long-term goals at the same time. Thinking about them consecutively means draining a savings pot and starting all over again. And even with the low interest rates on offer, the goal is to compound that growth over time, not chop it down and start again.
   

5. Rules of thumb when investing

1. Save first, then invest regularly and robotically. If you’ve decided investing is for you, make sure you have those emergency savings built up before you do anything. Then concentrate on investing periodically into those quality assets you think will grow over time. Don’t be tempted to try to time the lowest entry points. It’s nigh-on impossible and you’re much better in the market than out of it over the long-term.
2. Look to yourself before the assets. Your tolerance for risk, time horizon and ultimate financial goals are what will decide the mix of assets you put in your portfolio. Only once you have those questions answered should you be looking at how to pick investments.
3. Be a tax savvy investor. Before you go stock picking, make sure you are investing in the right account. The likes of an ISA or SIPP can help you invest tax efficiently, ultimately helping you manage how much tax on investments you end up having to pay.
4. Diversify, diversify, diversify. We don’t know which assets, geography or sector will lead the pack at any given time, so portfolio diversification is key. It’s all about having a squad of investments ready to take over from one another over the long term.

How inflation affects your savings

The Office for National Statistics (ONS) tracks the prices of items we tend to use every day, and distils the change in price of this overall basket into one percentage figure to give us an idea of what inflation looks like to consumers.

The ONS keeps an eye on over 700 products and services list now includes items like hand sanitisers, coffee, chocolate and electric cars. If our savings don’t grow at least in line with inflation, the value of what we’re actually able to buy with the pounds in our pocket starts to erode.

If you are simply stockpiling cash and not getting any growth on top of it, while your money will still be sitting there, the value of what it can actually buy is likely to be decreasing over time.

With interest rates so low, it’s one reason why many savers have considered turning to investing over the past decade. There is a higher level of risk to accept with investing, which will be a key consideration for savers looking to make that step into the markets.

It all depends on your goals, shorter and longer-term

You can be a saver and an investor at the same time. That’s because, when it comes to what you’re putting money away for, your time horizon will often make the decision for you.

If your financial goals require you to have that money pot ready to be spent within five years, saving is a better route from a risk management perspective. Investing over such a short timeframe introduces the possibility that the value your money could actually be down when you need it. 

That’s because investing works better the longer you leave it, preferably for at least five years. This allows income payments from dividend-paying companies to begin their snowball effect, and allows for those companies themselves to grow in general, beyond short-term ups and downs in the share price.

For high quality investments, the longer you leave them, the smoother their stock market journey can look. If you zoom in, it can all look a bit spikier - that’s not the short-term environment you want to be in when you have to take money out.

Your time horizon will have a huge bearing on the right route for you.

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What is better paying off a loan with investing or saving?

Pay off any unsecured debt like credit cards before investing. The reason is simple. Long-term investing takes advantage of your money compounding over time. But that compounding can also amplify your debt. 

As valuable as compound interest is for your savings, it is just as damaging when it is working against you. That’s why it’s so important to address this debt early and pay it off to stop the negative compounding, before you invest and hopefully take part in the positive side.

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Savings vs investment ratios

What percentage of my income should I save?

This question comes up a lot, we’ll take it to mean how much you should put towards your financial goals each month through savings and investments. 

And it depends entirely on your goals, ability to save, time horizon and tolerance for risk. 

Rough guides like ‘put 10% of your pay cheque’ into your savings risks being too broad. That might not be viable given your other financial commitments or it might be far too low a level, given your financial goals. When it comes to investing that money the question changes from how much, to how early and how often. The clear answers here are early and often.

Nothing beats the value of time in the snowball effect you want to build up through growth and dividends racking up. Starting early and adding steadily to your investments can really help over time.

How much money should I save before investing?

It’s wise to keep three to six months’ worth of your salary as a safety net before you start investing. It’s an important foundation to make sure you don’t have sleepless nights if the car breaks down or you need quick access to money. The last thing you want is to stunt your investment growth or even end up having to sell when markets are down.

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How much from my savings should I invest?

Once you have built up your safety net, the next step is to decide how much of the cash you are putting aside each month should go into your investments, and how much in cash. 

You can hold cash in the likes of an ISA, SIPP or general investment account (GIA) and it can be useful to top up holdings going through a temporary dip. 

But remember why you have chosen to invest. If you already have that sensible back up store, holding more cash could be a real drag to overall investment performance. It may be that you keep around 5% of cash in your investment account to capitalise on market dips but know that the longer it sits there the longer it isn’t working hard for you.

Savings by age

Our short-term goals can be wildly different from each other but one thing we all have to consider is how we plan to save and invest for our retirement.

A good rule of thumb here is to have x1 your annual salary in your pension by the age of 30, x2 by 40, x4 by 50 and x6 by 60. For most young people, the state pension will kick in from the age of 68 and it’s a sensible guide to have x7 your current salary saved by then.

Rough guides like these can be useful yardsticks to measure how you're doing and plan your own journey.

These numbers might raise a few eyebrows but remember, if you are investing for the long term, those smaller regular pension contributions you make in your 20s and 30s can really multiply later on thanks to the magic of compounding.

These numbers aren’t meant to be precise but they are meant to give a guiding hand to those wanting to have a similar standard of living in retirement as they have now. Of course, you can increase those payments if you want to boost that standard or if you want to retire earlier.

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How much do I need to save for retirement?

How much you need to retire is a key question for all of us.

Having x7 to x10 your income at the point of retirement is often the range quoted to maintain your lifestyle through your third age.

But there are two considerations to include here: when you want to retire and how you plan to live during retirement.

Younger people in particular will see changes to what they might want from retirement and what they can realistically plan for throughout their lives.

That’s because they are still likely to have a lot of life’s key expenditures ahead of them which will constantly change perceptions of value and will steadily refine what they deem to be achievable or even desirable standards of retirement living.

House deposits, weddings, children and all the life goals that often require money before we get to retirement ages will have a knock on effect here.

And that’s not even taking into account our salary trajectories, which can change massively over the years.

But we should take into account that, by and large, by the time retirement comes we’re likely to have fewer or lower expenditures than during our working lives.

A lot of people use their 25% tax-free cash from their pension upon retirement to help pay off their mortgage for example.

And by then the likes of childcare and the daily commute will probably be a thing of the past too.

With housing payments, often the biggest single expense, out of the way, this tends to mean we only need around half to two thirds of our final salary to achieve a similar standard of living as pre-retirement.

Saving goals

Short-term savings (unexpected situations, emergency fund)

It’s sensible to build up an emergency pot for two reasons. The first is that savings already in cash can be accessed quickly and easily. You could feasibly sell investments quickly but there are always settlement periods and it may be that your money needs to land in your investment account first before you can move it into your bank. 

The second reason is that unexpected situations can already be stressful without having to stunt your own investment growth or worse, realising your investments are down at that very point.

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Long-term savings (five years and beyond)

Compounding is a bit of a super power. But its true potential only really becomes clear over time. Building interest on interest might not feel immediately beneficial but the longer you leave it the better it gets. 

In this equation there is simply no substitute for time. That’s why most investors take at least a five-year to their holdings. That’s enough to let the companies you’re investing in demonstrate how they plan to create value and it’s also enough time to see what sort of dividend consistency a firm has.

Investing for less than five years increases the chances that the value of your investments may be down when you need it, as the time necessary to allow that compounding simply hasn’t been there enough.

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Best place to put savings to get better returns

A lot of savers have turned to the stock market since the financial crisis, as interest rates have plummeted. But it really needs to be stressed that pursuing higher potential returns also comes with the caveat that there are higher risks attached.

Savers should keep this in mind. But that doesn’t mean that all companies on the stock market bring a wild risk profile to the party.

In fact, savers and bond investors starved of interest have sometimes seen attractive qualities in large dominant companies offering attractive dividend yields and widely diversified business models. These huge corporates, often making things like household essentials or popular consumer products, have loyal followings and the ability to stave off competition through pricing power and huge stables of well-known brands.

There is no guarantee that companies like these will perform in the future as they have done. But it’s a simple illustration of how adopting risk does not necessarily mean taking a punt on a stock that might explode upwards or downwards.

Are you ready to start investing?

Risk

If the thought of climbing the risk scale and having your portfolio move up and down from day to day scares you, investing might not be for you.

But risk goes further than short-term volatility. Ultimately, risk is about measuring how likely your investment is to fail outright. That puts choosing between small, plucky companies and large established firms into perspective. They’ll both have their volatile periods but there might just be different perceptions of how long-lasting their entire models are.

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Diversification

It’s time to talk eggs and baskets. Diversification is investing 101 and helps reduce the overall risk of your portfolio by adding in assets that act differently from each other. The theory is that, as there are so many different (and sometimes opposite) influences on assets like equities and bonds, when one drops another should be able to pick up the slack. Diversifying by geography and sector also spreads the risk, diluting the effect any one country or company can have on your portfolio.

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Compounding

Sometimes savers enter the stock market thinking it’s about taking a bet on a company they think will shoot the lights out and explode their savings immediately.

But good investing is about building up growth over time, not overnight. When a company pays a dividend and you reinvest it back into that firm, the next time there’s a dividend payment your original payout will generate a return of its own.

For example, investing £100 and receiving an annual 4% dividend means you could have £104 if the share price doesn’t move. That same 4% yield the year after will pay out £4.16 as the first dividend has now generated its own income.

The among of times your investment can compound like this relies entirely on how long you leave it. Remember, investing is about time in the market, not timing the market.

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What to invest in?

On Freetrade there is a wide range of assets you can invest in, including US and UK stocks and shares, investment trusts and ETFs. If that all seems like a foreign language you might like our beginner’s guide to the stock market. We also have a resource hub for investing in the stock market to get a wider view of investing in general.

What a company offers in terms of assets, customer service and ease of use should all come into the conversation when you’re deciding how to choose the best investment app to suit your needs.

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Type of accounts

Getting the account to suit your goals is an important way to kick off your investment journey. 

With a stocks and shares ISA (you might hear it called an investment ISA too), you can invest up to £20,000 a year and won't have to pay capital gains tax (CGT) on any gains your investments make inside the ISA account. This can be particularly useful for any goals you have up until retirement.

For those retirement-focused savings and investments, a SIPP account might be attractive. In a self-invested personal pension you can bring together any loose pensions from previous employers into one place. 

There are a lot of benefits to both accounts, namely the tax efficiencies they bring. If you find a provider that better suits your needs in the assets they offer, price or ease of use, you can always think about moving your ISA or SIPP through a transfer. You need to make sure that would be in your best interests beforehand though. If it’s something you’re thinking about read our guide to transferring your ISA to another provider.

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How to decide what to do with your money?

Only you can decide if saving or investing, or a combination of both, is right for you. That’s because we all have different goals, different time horizons and different tolerances for risk. Weigh up the pros and cons of both saving and investing and make them applicable to you and your life. The information out there may be generic guidance but making it a lot more personal will show you how you can do what’s right for your own financial future.

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Is it better to invest or save?

As we’ve been able to work out. It’s not about which is best, it’s about which is more applicable to your personal circumstances. For some people with low risk tolerances and imminent financial goals, saving might just be the best choice. For those with super long-term goals and the ability to put up with market volatility along the way, investing might be able to help.

It’s about doing what’s right for you. The information is out there, make it work for you.

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We think investing should be open to everyone. It shouldn’t be complicated, and it shouldn’t cost the earth. Our stock trading app makes it simple for both beginners and experienced investors. And costs are low. You can buy and sell shares commission-free and take advantage of fractional shares (buy just a part of a share). 

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Important information on ISAs and SIPPs

SIPPs are a pension product designed for people who want to make their own investment decisions. You can normally only access the money from age 55 (potentially 57 from 2028). Current rules can change, and tax relief depends on your personal circumstances.

Before transferring an ISA or pension you should ensure that this is the right thing for you to do and in particular you will not lose valuable guarantees or incur excessive transfer penalties. 

Pensions are usually transferred as cash so you will be out of the market for a period and therefore there is a risk you may lose out on investment gains during this period.

Freetrade does not currently offer drawdown products for our SIPP.