This is an age-old question that many people are still asking themselves; should I save, or should I invest? The following article will outline the difference between putting your money away or trying to make it grow and the associated risks, as well as which option may be the most appropriate for you based on your current financial position.
What is saving?
Saving is the process of allocating money over a set period of time, such as every week, fortnight or month and putting it away to ensure you have cash on hand for a rainy day. This may involve keeping the money in a term deposit or a savings account at a financial institution. Saving can be a viable option if you need to establish an emergency fund for unexpected expenses or if you are planning a holiday or have some big upcoming payments. Setting a savings goal is vital if you wish to maximise your savings potential. This may entail starting a budget to gain a more comprehensive understanding of your cash inflows and outflows, setting up an automatic direct debit into your savings account or changing some spending habits to minimise your day-to-day expenses. The amalgamation of these simple steps overtime really can make a big difference. Although this may feel like a relatively safe way to ensure you have money that is liquid, there are also other options which may assist you in achieving long-term financial stability.
What is investing?
Investing on the other hand involves using your money to grow your wealth by purchasing certain assets that could increase in value overtime and thus generate a positive return. Some investment assets include direct shares, ETFs, managed funds, property, bonds and cryptocurrencies. However, the type of assets that you choose to invest in will be contingent on a range of factors such as your current financial position, the level of risk you wish to bear and the amount of money you wish to invest.
When should you save?
There are times where saving should be your main focus and should be prioritised over investing. A good rule of thumb to follow, is ensuring you have three to six months’ worth of living expenses available in cash. This will provide a safety net if you encounter some unexpected life challenges. To discover some budgeting tips, click here. Another priority over investing is paying off high interest debt. What constitutes high interest is subjective, however any debt which has an interest rate of 10% or more should be paid down.
When should you invest?
Making the decision to invest some of your money is really a choice that is dependent on your long-term goals as well as your appetite for risk. This is because if the market drops in value, you need both flexibility and time to allow it to recover before you sell. A longer time horizon will facilitate for a riskier investment approach, but you must first understand the difference between short term volatility and the actual risk of losing money.
Volatility vs the risk of loss
Volatility refers to the degree to which a share price fluctuates overtime. Short term volatility will often see a steep rise and fall in the market, however, the standard deviation overtime is often more consistent and predictable. Volatility is impacted by a range of factors including tax, interest rate policies, changes in inflation as well as various industry factors. However, when investing, it is crucial that investors take a long-term approach as volatility can be used as a powerful vehicle to help generate positive returns.
This concept must be contrasted with the risk of a permanent loss of capital which occurs when investors react to short term volatility and sell their investments at a loss. This can be combatted by riding out and not reacting to these market downturns as well as ensuring you maintain a diverse investment portfolio. Diversification involves investing in a wide variety of asset classes. This includes investing in domestic and foreign companies over a range of sectors in both defensive and growth assets. Doing this can reduce the impact of short-term volatility as different investments react in different ways and therefore it really is important to not put all your eggs in one basket.
Determining your risk tolerance
Understanding your tolerance for risk is vital to determine the type of assets you wish to invest in. This decision will also consider your risk capacity, which is the amount of risk required in order to generate a certain level of return and thus meet your financial goals and objectives. Your risk appetite will also be informed by your age and whether you have time to bear market losses, or are closer to retirement and therefore need to be more careful in your approach. Whether you have any financial dependents will also influence the level of risk you are willing to tolerate as it will inform how much you can afford to lose. Your financial goals are also a major factor that will impact your risk tolerance. Investors who wish to live a more luxurious lifestyle may be more akin to higher risk investments as they have the capacity to make higher returns.
Another consideration which investors must take into account is their emotional response to loss. If you respond to bad news with panic or have a knee jerk reaction, a high-risk investment may not be for you, as irrational decisions could be more detrimental to your portfolio in the long term. Determining the level of risk you wish to bear should be careful and involved decision. If you require some assistance with making this choice, you can speak to an EPG Wealth adviser here.
Managing risk?
With investing come risk, however, there are some strategies which individuals can implement to mitigate these potential losses. As previously mentioned, having a diversified portfolio is imperative to reducing the impacts of volatility and market downturn. This could include both defensive assets such as fixed interest, government bonds and cash investments as well as more aggressive assets like direct shares, managed funds, ETFs and cryptocurrencies. It is also important that individuals invest consistently and do not try to pick the right stock at the right time. It’s not about timing the market, but time in the market. To read more on this topic, you can click here. Finally, to ensure your money is working as efficiently as it can overtime, seeking out professional investment or financial advice is a useful tool to help you achieve your long-term investment goals. If you would like to speak to a financial adviser to assist you with your portfolio or look into setting one up, click here.