Differences between Saving and Investing

Save or invest? This is a question that we all have at some point in our lives. Although some people may think that the difference between the two is quite trivial, the truth is that they are two very different concepts, each with its own purpose.

In this article, we will analyze the differences between saving and investing. We will explain why it is not necessarily about choosing better but finding the right balance between your savings plans and your investment portfolio.

What is saving?

Saving involves depositing your money in a separate place, usually in a bank, either a savings account or a checking account. 

People may be saving for a specific purpose, such as a deposit for a house or simply saving the money for the future.

This money intended for savings is easily accessible in case of need; in other words, it is very liquid. 

If it is kept in a bank, the money is insured by the Deposit Guarantee Fund (FGD), which means that if your bank fails, the first $100,000 of your savings will be returned to you.

What is investing?

Investing also involves depositing your money in a separate place for the future. However, the main purpose of investing is to use your money to create more money and make you richer. This is done by purchasing assets, which an investor believes will grow in value over time or generate income.

There are many options available to people who want to invest their money, such as bonds, stocks, exchange-traded funds (ETFs), and mutual funds, to name just a few.

Unlike savings, money placed in investments is not insured, and therefore any investment runs the risk of total loss. However, the level of risk varies between different financial instruments; For example, buying Spanish government bonds carries much less risk than buying shares in a company that has just been created.

In addition, the capital invested is much less liquid than the capital found in a financial institution. Unlike a bank, where you can generally withdraw money whenever you want, liquidating an investment is often more cumbersome and sometimes involves finding a counterparty willing to buy your asset.

The Risks of Saving vs. Investing

We've looked at what saving means and what investing means. In doing so, some similarities and differences between saving and investing have been highlighted, including the concept of risk, which we will develop further below.

Risk and return are two of the key differences between saving and investing. Saving money is a low-risk activity, where the potential return is strictly limited to the current interest rate. On the other hand, investing can carry a much higher risk, but it carries unlimited potential in terms of returns.

Inflationary risk

We have reported that the money in a bank in the USA is insured up to $100,000, making it a safe destination for your cash. However, that does not mean that having money in a bank is risk-free.

Since 2008, the European Central Bank (ECB) began a monetary policy of low-interest rates that have remained at a minimum and close to 0% since 2014. At the moment, there are no signs of a possible increase in rates immediately. Therefore, the risk of keeping money in the bank is that the inflation rate will exceed the interest earned on your savings.

Inflation represents the decline in the purchasing power of a currency over time caused by rising prices in an economy. If the inflation rate is higher than the interest rate, the money you keep in a savings account loses purchasing power over time.

Default and market risk

Although inflation risk is also present when investing, the most serious risk is that the investment will lose some or all of its value. As mentioned above, this risk varies depending on the instrument you choose to place your money.

When you buy bonds, you are essentially lending money to the bond's issuer to repay it at maturity and perhaps to pay interest during this time. Therefore there is a risk of breach of contract.

Investing in government bonds such as the US carries little risk, as long as you intend to hold the bonds to maturity. Although it is possible, a government like that will default on its sovereign debt contract is very low.

This is not to say that all government bonds are a safe investment; it will depend on the government that issues the bond. For example, since 1827, Argentina has defaulted on its public debt contracts nine times, a world record.

With investments such as stocks and funds, there is a risk that the market will not move in the desired direction, and, as a result, loss of capital will occur.

All this is to say that it does not matter where you deposit your money since there will always be a risk. Before investing your money, it is important to create a risk management plan to help anticipate and hopefully minimize the associated risks.

Saving vs. Investing - Differences

Initially, it is necessary to save to invest, always prioritizing saving. Even the most ardent advocate of investing will likely emphasize the importance of having savings available if something unforeseen happens.

One of the most frequently asked questions is: what percentage of my savings can I invest? No rule indicates how much money you should put in savings; however, having enough to cover your needs for at least three months can be a good way to start.

⚠️ Only once you have saved a sufficient amount can you start investing, and you should never invest the money you need to live.

The intention of investing is to create wealth in the long term, which means that you should not invest money that you will need in the short term. The reasoning behind this is twofold.

➤ First, as we noted earlier, money put into investments tends to be less liquid than money put into a savings account, which means that your money will not be available when you need it.

➤ Second, and perhaps most importantly, the volatile nature of financial markets means that you may not see a significant profit, or even you may not see any profit in investing in the short term. 

Price fluctuations in the short term could significantly affect the value of your investment, while these fluctuations tend to smooth out in the long term. Additionally, entering and exiting positions in the financial market tends to incur brokerage fee expenses and capital gains taxes, reducing any potential short-term profit.

Next, we are going to offer several examples of saving and investing. You can download the MetaTrader 5 trading platform and see the evolution of assets in real-time. Is free!

What is better to save or invest in 2021?

As mentioned above, any investment involves risk, and it will be necessary to consider the investor's risk profile and the investment time horizon before deciding on the matter. 

However, it is possible to compare investing and saving in 2021 and to know different investment options.

How profitable would a savings account give me in 2021?

In 2021 the profitability offered by financial institutions is minimal. To achieve higher returns, it is common for entities to request a greater degree of commitment from the client. 

It is possible to increase the profitability of savings accounts by including other products such as incorporating payroll, receipts, mortgage, and/or insurance. 

In addition, the competitiveness to get customers is very high, so some financial institutions offer gifts to attract customers. This information can be verified individually on the web pages of each bank or in market comparators such as help cash.

With the information on its website, the following table has been prepared that includes the remuneration of some savings accounts.

Entity	Orange Bank	Renault Bank	PiBank	National Netherlands	Brabank
Cost effectiveness	1 %	0,65 %	0,50 %	0,30 %	0,17 %

Source: dotbig.com on May 27, 2021 at 3.05 pm CET.