best way to invest money, Saving Vs Investing The Differences?

A fundamental idea in finance is the contrast between saving money and investing money. Even though these terms are sometimes used synonymously, they are actually very different and should never be confused. In this article I will outline the differences between the two, allowing you to get off to a great start with your investing career.

One of the key differences is due to a concept known as liquidity. This refers to the ease at which an asset can be bought or sold. Cash stored in the bank is an example of a highly liquid asset. It can be redeemed rapidly without penalty. A rental property is an example of an illiquid asset. To sell the property requires time and strong demand, otherwise a penalty is incurred in the form of reduced price for the sale.

The Differences in Saving and Investing

Saving and investing are generally defined by their differences in liquidity, as well as the expected return earned on any potential asset.

Saving involves placing cash into a bank current account, bank savings account or into a Cash Individual Savings Account (ISA). At the current base rate of interest in the UK, these accounts are unlikely to generate an attractive return on investment. The goal of saving is to ensure that you have access to cash for the day-to-day situations. In particular - emergencies, an unexpected redundancy, a house deposit, university tuition fees.

Since cash is highly liquid, it can be deployed easily in these situations. The disadvantage of saving cash is that the interest rates offered by banks/ISAs is rather low. These rates often only match the current inflation rate. In another post I have advocated creating a cash liquidity buffer.

Investing differs substantially from saving. It involves deploying cash to purchase an asset that generates a return over a particular time-horizon. This return can take the form of a capital gain, which is when the sale price exceeds the purchase price. It can also take the form of a dividend or coupon, which is a quasi-consistent variable payment, usually the cost of lending money or a share of the profits from a business.

Investments are often (much) more illiquid than cash and most are designed to be held for long periods in order to see significant returns. There are a great deal of assets available to the investor, each of them requiring a substantial degree of experience in order to generate a solid return on investment:

    Residential or Commercial Property
    Government and Commercial Bonds
    Equity Shares - Common Stock and Preferred Stock ("the stock market")
    Investment Funds - Index Trackers, Exchange Traded Funds (ETF)
    Collectibles: Art, Stamps, Cars, Wine
    Private Small Businesses

When To Save and When To Invest

Unless you are part of the genetic lottery and have inherited a great deal of wealth, then in order to begin investing it is necessary to first begin saving. Once you have sufficient savings you will be in a position to begin purchasing investment assets.

Generate a cash liquidity buffer by keeping 9-12 months of monthly expenses in ready, liquid form. Leave this alone in a Cash ISA of high-interest savings account. Only then will you ready to begin investing.