Deciding what and how to save or invest depends on a number of factors, including how much surplus income you have, how much capital you already have and the amount you would need to be able to access in the event of an emergency or unforeseen circumstances. You also need to think about what, if any, debt you have and whether you would be better paying this down with some or all of the money you are thinking about saving or investing.
Of course, what you are planning to do with the money and when you need it will also have an impact on your savings and investment strategy. In fact, research shows that the time for which an investment will be held should be the bigger factor in deciding how much risk to take rather than the outlook of the individual investor.
Are you looking to save or invest?
The first thing to establish is whether you want to save money, invest it or a combination of the two. Savings usually refer to cash or ‘near cash’ options such as NS&I Bonds. Cash savings can be attractive because they generally will never go down in monetary value, they are usually guaranteed by the Government subject to certain limits and they are normally easy to understand and surrender if you need to.
That said, if your circumstances and objectives allow, you can sometimes tie your money into a fixed term ‘bond’ – you should be rewarded for the commitment with a higher interest rate than savings that are immediately accessible. Don’t confuse this with an Investment Bond, which is a type of wrapper for holding savings or investments. Indeed cash savings can be held directly in an ISA in certain types of pensions, investment bonds and other wrapper structures.
So, what’s the downside? Inflation. Historically average rates of cash interest have historically provided returns lower than the rate of inflation meaning that cash savings have fallen in ‘real’ value – i.e. what you can buy with your money.
Because of this, some people choose to invest their money. Investments generally refer to any asset that can be traded and may include shares, fixed interest (loans to companies and governments), property, commodities or alternative investments (such as aircraft leasing or wine). The key difference for most investors in these assets is that they are looking for an increase in the value of their initial capital as well as, in most cases, an income similar to the interest paid by cash savings.
This increase of the investment amount offers protection from inflation, hence over the long-term investments tend to make more sense than savings. However, as well as going up the capital value can also fall, meaning the there is risk involved in investing that some, or even all, of your money might be lost.
If you remain invested, losses tend to be made back over the long term so people are usually advised to only consider investment if they have a time horizon of five years or more.