Deciding whether to invest or save your spare money depends on a few key factors:
1. Emergency Fund Status
If you don’t have 3-6 months’ worth of living expenses saved, concentrate on building that first. Once you have emergencies covered off, then you can start to think about your next priorities.
An emergency fund should hold enough money to cover your essential monthly expenses (water, gas, electric, rent/mortgage, council tax, food, transport to work, insurance, and any debt repayments) for at least 3 months.
2. Your Financial Goals
The rule of thumb is that if your goals are short-term, you should save. By short-term, we mean anything you might need to access the money to pay for within the next 5 years.
If you need the money soon, to cover emergencies, or fund a holiday, deposit on housing, or other large, one-off expenses, then it makes sense to put your money into an easy-access savings account. Look for an account that doesn’t penalise you for making withdrawals and offers a high rate of interest. We’ve got a list of the top-paying accounts here.
If your goals are long-term, but which we mean you can leave the money untouched for at least 5 years, then investing offers the potential for higher returns. That’s because, historically, investing has tended to yield higher returns than savers have been able to gain through interest on cash accounts. As an illustration, the average annual return on UK cash savings accounts over the last 10 years has been around 2.57%. Compare that with the 10.6% someone invested in the S&P 500 index would have gained annually.
So, if you’re thinking about retirement, wealth-building, saving for your child’s education, building your own home, or any other goals that are in your long-term view, then investing in the stock markets could mean higher returns.
The reason we don’t advise investing for short-term goals is that if you need the money quickly, you may be forced to sell an investment when it’s experiencing a dip. That locks in your losses. If you have time, you can choose the optimal time to sell.
2. Your Risk Profile
It is important to remember that investing does come with risks, however. And while past performance data does show investing offers higher potential returns, this is not guaranteed, and you could lose money.
So, it’s vital that you spend some time reflecting on your feelings about risk. Ask yourself how much risk you are comfortable taking (you’ll often hear this referred to as your ‘risk appetite’) and how much can you afford to lose if things don’t go your way (this is your ‘risk tolerance’).
If you have a low risk tolerance and/or a low appetite for risk, then look at less risky investments or stick with savings. Not all investing carries the same amount of risk; some types of funds focus on more stable investments such as bonds, for example. Or take a look at low-risk Money Market Funds, which are increasingly popular with more risk-averse investors.
If you are okay with some level of risk, and you already have money saved to cover emergencies and short-term goals, then investing may be a good option for you. Again, not all investments carry the same amount of risk. The key is finding a solution that aligns with your risk appetite, risk tolerance, and your goals. Crucially, it’s also vital you understand how to mitigate risk through fundamental investing principles such as Diversification is an investment strategy that involves spreading your money across different assets to reduce risk. The idea is not to place all your eggs in one basket. The benefit of this approach is that when one losses are felt by one type of investment asset class, it is rare that other asset classes are equally impacted. diversification
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The Best Strategy is a Mix
Ideally, you’d keep emergency and short-term funds in savings. That provides peace of mind and immediate solutions to immediate problems. But with any extra money, that you don’t immediately need, investing in the stock market provides the potential for greater long-term growth.
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