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Saving vs. investing

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Lesson time
4 min.

In this lesson you will learn 💸

  • All about the difference between saving and investing
     
  • What makes money grow (or not): interest and inflation

To make your money grow you have two basic choices

  1. You can either leave it where it is, e.g. in your bank account, or
  2. You can invest it.

Think of it like fitness. If you want to be healthy, it’s up to you to get active. If you want to be financially secure in the future, it makes sense to do something positive with your money now.

Difference between saving and investing in 2 columns and 8 bullets, where investing makes your money work and saving keeps it safe

Saving

Is usually for something specific, e.g. a holiday, or a rainy-day fund.

You might allocate a certain amount every month or so and want to keep it somewhere you can access it straight away (such as a savings account).

Investing

Is where you take a chunk of your money and try to make it grow.

You do this by buying something that you think will increase in value. It could be as simple as a collectible Wonder Woman figure, or, more likely, stocks, bonds or crypto.

It's time for a quiz 🎯

How much would you have today if you had invested £100 15 years ago (assuming a conservative estimate of the return rate)?

😕 Unfortunately that's not correct!

Why not giving it another try?

👏 Correct!

That's how much you would have if you had invested £100 with a 5% return, compounding once per year. Note that this result is not adjusted for inflation.

*calculated with the calculatorsite.com compound interest calculator, June 2022.

😕  That's not correct!

This amount is what you would get if you had saved the £100 on a savings account and got a 1% interest rate, compounding once per year. Note that this result is not adjusted for inflation. So your money actually would have less purchasing power as well.

*calculated with the calculatorsite.com compound interest calculator, June 2022.

Types of investment income

When you invest, there are three types of investment income:

Types of investment income: dividends, interest, capital gains

What are dividends and capital gains?

Dividends: are a type of income that shareholders of specific companies receive. They are formed from the company's profits and are paid out on a share basis. Shareholders usually have the option to use their dividend cash or reinvest them.

Capital gains: A capital gain happens when you sell an asset for more than what you paid for and are generally associated with investments, but it can also be realized on any possession that is sold for a price higher than the original purchase price.

What is inflation?

The average price increase of goods and services over time (according to the Consumer Price Index). A country in good economic condition is typically accompanied by a steady slow increase in prices. However, if inflation rises sharply, it not only reduces the value of money, but it can undermine trust in that market.

What is interest?

If you’re borrowing money, it’s the extra amount you pay for the pleasure. So, if you borrow £100 at 10% interest, you’d have to pay back £110. However, if you're lending money, you’d lend the £100 and get £110 in return.

What is the Real Interest Rate?

Pick an answer below (there might be more than one right answer) 😉

👏 Correct!

The Real Interest Rate gives an idea about the real cost of money borrowed and the real yield of an investment. 

😕 That's not correct!

Interest paid on interest is the "compound interest". The Real Interest Rate gives an idea about the real cost of money borrowed and the real yield of an investment.

For example, if your investment was due to earn 3% over the next year, but there’s also an inflation increase of 1%, then the real interest rate would be 2%.

👏 Correct!

If your investment was due to earn 3% over the next year, but there’s also an inflation increase of 1%, then the real interest rate would be 2%.

What is compound interest?

Time can make a huge difference to the amount of return you’ll see you on your savings and investments. The more interest you make, the more money you’ll accrue (as interest is paid on your interest). This is called compound interest.

Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.

Author
Albert Einstein

What would you do? 🎯

Should you invest the money for your next holiday in 6 months, or invest it?

👏 Correct!

Saving is usually good for something specific in the near future, and if you want your money to be available in the near future. But if you wanted to have holiday 8 years from now, you might be better off to invest your money😉

🤨 That's not fully correct

Saving is usually good for something specific in the near future, and if you want your money to be available immediately. Your well deserved holiday is in 6 months, so not that far out. If you invest your money for such a short period of time, you are facing a rather high risk of the investment not going as planned. 

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