Lesson 1: Saving vs investing

Many people consider saving and investing as alternatives. But it’s really the way you combine saving and investing which can have a powerful effect on your wealth.

Saving typically results in earning a lower return but with limited risk. In contrast, investing allows you the opportunity to earn a higher return, but you take on the risk of loss in order to do so.

While saving and investing both involve setting money aside to save for the future, there are some key differences to understand.

If you were to keep your money in a piggy bank and not invest, you’d never have more money than what you’ve stashed away yourself. And if you were to keep your money in a bank with low interest, it will generally only grow by a fairly low margin.

The goal of investing is to make more money than you originally put towards the investment.

If you had $10,000 saved in a bank account earning 2% interest per annum over 30 years, it would grow to $18,113.62 – that’s only $8,113.62 earned.

A $10,000 investment that earns 8% per annum over 30 years will grow to $100,626.57 – multiplying more than five times over.

The main reason for the dramatic difference to the example above is the rate at which interest compounds. Compounding is one of the fundamental components of wealth creation and a phenomenon famously coined “the eighth wonder of the world”.

You can think of compound interest as a self-fulfilling cycle, where your investment earns interest, and then your interest earns interest, creating a snowball effect.

Compounding means that your wealth can grow faster over time, because you’re not only getting returns on your initial investment, you’re also getting returns on your returns.

While any investor can take advantage of compounding, the greatest benefit goes to those who get started early. The best way to explain this is through a simple case study.

As you can see in the hypothetical on the right-hand side – delaying the start of your investment journey by 10 years could make quite the difference in the world of compounding.

Holly has only contributed $12,000 more to her investing ‘pot’ (10 years x 12 months x $100) – but ends up with more than double Ben’s final nest egg.

If you give your money enough time to compound and add to it along the way, it can grow into much greater wealth.

Source: Betashares. Hypothetical example provided for illustrative purposes only. Past performance is not indicative of future performance. Not a recommendation to make any investment or adopt any investment strategy.

There is a time and place for both, so you should base your decision on your situation. A rule of thumb suggests your decision should come down to two things – time and risk.

If you think you need ready access to your money within a couple of years – like for a house deposit or your own business – it may make more sense to save. This is because if the sharemarket falls, an investment may not have enough time to recover before you need the funds.

But if you have a longer period of time before you might need to draw on your money – such as three or more years – then investing may make more sense.

Generally, the longer your timeline, the more important it is to consider investing vs saving.