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Saving and Investing

Saving and Investing

People often start thinking about investing when they realize they will most likely need extra income to cover emergencies or unforeseen expenses in the future. With inflation increasing rapidly, even young people have started thinking about saving and investing money now to have a more comfortable lifestyle in the future. The main point is that you don't have to earn a lot or be rich to start saving and investing. All it takes is discipline and some strategy. Ready to learn how to better manage your personal finances by saving and investing? Dive into this article for more!

Saving and Investing Meaning

What does it mean to start saving and investing? Well, it may not sound simple, to begin with. Still, you will be able to understand it once you learn some of the key terminologies and apply them to your everyday life. But in a nutshell: both saving and investing are money management tools.

To dive deeper into money management, click here: Money Management.

Saving is a habit: a habit of setting aside a part of your income at regular time intervals instead of simply spending it. And it doesn't have to be a large amount of your income if you start early and do it regularly, with discipline. With investing, however, unlike with saving, there are multiple strategies.

It is estimated that households in France saved about 13.8% of their income in 2018. Compare it to the United States, where families saved only 7.7% of their income in 2018.1

People do save. But what are the real benefits of saving? Is it really worth it, given astonishing inflation rates? Even if you are saving for retirement, savings can be your safety net in case of any real future financial troubles. Life does happen, and the prospect of having some savings set aside without having to rely on anyone can make you sleep better at night. With interest on interest, also called compound interest, you can accumulate quite a pot if you start early enough. Finally, having a set amount in a savings account can improve your credit rating, which may be pivotal if you want a mortgage to buy a house.

Saving is a habit of setting aside a part of your income at regular time intervals instead of simply spending it.

What about investing? Like saving, successful investing starts early and utilizes the principle of compounding. However, investing is a little more involved than saving as it involves different strategies. Many people reach out to investment advisors and brokers to help them out. Alternatively, you can start investing yourself, but you need to learn more and know what you are doing.

One investing strategy could be similar to what Warren Buffett does. He searches for stocks with a high intrinsic value currently undervalued by the market. This indicates that there will be future earnings potential. Alternatively, you can invest in well-established companies like those that are part of the FTSE 100 Index, whose stocks are traded on the London Stock Exchange.

Regardless of your chosen strategy, you should never forget that you are balancing the risk and reward. There may be an investment that promises a hefty reward, but it may involve high risk. This means you are as likely to lose your entire investment as you are to reap the reward. On the other hand, there may be an investment that doesn't promise gold mountains but earns you a stable income over time due to steady growth.

Investing is strategically choosing to place money where it is expected to generate a return while also accepting the risk involved.

Saving and Investing Similarities & Differences

What are some similarities and differences between saving and investing? Well, both are, of course, money management skills. However, investing differs from saving because it is a little more involved. There are various investment options and strategies. There are only so many ways to save, but there are infinitely many ways to invest. In addition, you don't have to have money to invest to start with. You can borrow, invest, earn a return and then repay what you borrowed as long as you are sure that the return you get is greater than the interest on your loan.

Saving and Investing Strategies

What are some of the saving and investing strategies? Let's go over them in turn!

Saving Strategies

You can save your money in cash under your mattress, but it's a pretty inefficient way of saving. Why? One reason is simple; where do you store all that cash? Also, do you really want to risk all of your savings being stolen from your house? Finally, there is inflation - which means that your money's buying power will be declining daily in a rising price environment.

Another strategy is to open a savings account in a bank which gives an option of compound interest. Compound interest essentially gives you interest on interest at regular time intervals, such as monthly, quarterly, or yearly. The interest amount is added to the principal amount, making your future interest income even higher. Even though some banks may not necessarily offer interest that would keep up with the inflation rate, you can still earn quite a bit of return on your savings over a significant time horizon.

Saving and Investing Saving StudySmarterSaving, pixabay

The longer the time over which the interest is compounded, the more return you will get. Also, the more frequently the interest is compounded, the more return you will get.

Consider investing $100 for 1 year with no compounding. Imagine that annual interest is 2%. This means that at the end of one year, you will have $102 in your account.

Now consider investing the same $100 for one year compounded semi-annually. After half a year, you will have earned $100*2%*0.5=$1.

This $1 then gets added to your principal, and at the end of the year, you will get: $101*2%*0.5=$1.01.

With compounding, you have earned $2.01 in interest compared to $2 with no compounding.

Imagine you save $10,000 instead of $100 with compounding and leave the money to earn interest over 10-20 years! The returns become much more substantial than what you saw in the example above.

To learn more, check out our article: Compound Interest.

Investing Strategies

After putting some money aside, investing is basically the next step to earn you more interest than a regular savings account would. There are many ways to invest. Let's consider some of the most popular ones:

  • Stocks
  • Bonds
  • Treasury instruments
  • Real estate

Saving and Investing Investing StudySmarterInvesting, pixabay

When you invest in a stock market, you essentially buy a piece of the company you invest in. How so? Well, if the company is listed on the stock exchange, then it raises funds from the general public. This means that your money will be used to fund the company's day-to-day operations and, if it becomes successful, can earn you a decent return. You can buy a stock at a low value and wait for the price to rise and sell it. Alternatively, you can hold onto it and receive regular payments called dividends.

Governments and corporations often raise funding for their projects by issuing bonds. The general public buys these bonds and holds onto a piece of paper that promises that the issuing entity will return this money at a future date with interest. This future date is called the maturity date. Generally, bonds are considered a less risky investment than stocks simply because the entities that issue them have a better reputation in the financial market. In addition, companies that issue them do everything they can to fulfill their promise to repay, knowing that if they don't make their bond payments, their cost of borrowing will go up, and their reputation will suffer, making it harder to raise funds in the future.

Treasury instruments in the U.S. include Treasury Bills, Treasury Bonds, and Treasury Notes. All of these are ways you can lend some money to the government and earn some interest at various maturities. These are considered the least risky investments as you can buy them directly from the government, and there is a very low probability of a government default.

Finally, you can invest in buying a property you can live in and pass down to your children, thereby lessening their future financial burden. It is generally a good idea to take out a mortgage and repay it in installments at regular intervals. The catch? You often need a large down payment and a good credit score. In addition, you are paying the interest on your mortgage. The return will be positive only in the case that the future value of your property rises above what you bought it for, plus the interest you paid on top.

The Role of Savings and Investment in Economic Development

Savings and investment affect economic growth, which indirectly feeds into economic development. The ideas work the same as for an individual, but on an aggregate level.Economic development implies improving people's living standards. But how are the living standards measured? Various indirect factors correlate with a higher level of economic development, such as high real GDP per capita, low unemployment, low and stable inflation, a sustainable level of the national debt, and a balanced balance of payments. These can be achieved through economic growth.

Learn more in our article - Economic Development

Saving and Investment Relationship

Saving and investment are linked at an aggregate level in the loanable funds market. Banks loan out the money you put in your savings account to other individuals and businesses. All individuals' savings comprise the total amount of loanable funds that the banks can advance as loans. The more money is saved on an aggregate level, the more the supply of loanable funds will be. Greater availability of credit results in lower interest rates. This stimulates more firms and individuals to invest, as they can now borrow money for their investment at a lower interest rate. Ultimately, the more savings there are, the more investment there is in the economy.

Saving and Investing Saving in the loanable funds market StudySmarterFigure 1. Saving in the loanable funds market, StudySmarter Originals

Figure 1 above shows what happens when more individuals in the economy decide to save. The supply of loanable funds increases from S to S', leading to a drop in the interest rate from r to r'. At this lower interest rate, the quantity of loanable funds demanded is higher (Q' compared to Q).

Saving and Investing - Key takeaways

  • Saving is a habit of setting aside a part of your income at regular time intervals instead of simply spending it.
  • Investing is strategically choosing to place money where it is expected to generate a return.
  • Saving and investing are both money management skills. However, investing differs from saving because it involves various strategies, and you can borrow money to invest.
  • The four most popular types of investments are:
    • Stocks
    • Bonds
    • Treasury instruments
    • Real estate
  • Saving and investment are linked at an aggregate level in the loanable funds market. Ultimately, the more savings there are, the more investment there is in the economy.

References

  1. Statista, Gross savings rate of households in selected countries worldwide from 2010 to 2020, https://www.statista.com/statistics/246296/savings-rate-in-percent-of-disposable-income-worldwide/

Frequently Asked Questions about Saving and Investing

Saving and investing are both money management skills. However, investing differs from saving because it involves various strategies, and you can borrow money to invest.

The four most popular types of investments are:

  • Stocks
  • Bonds
  • Treasury instruments
  • Real estate

Saving and investment are linked at an aggregate level in the loanable funds market. Ultimately, the more savings there are, the more investment there is in the economy.

Savings and investment affect economic growth, which indirectly feeds into economic development.

It depends on your personal preferences. Individuals make distinctive choices about saving and investing because they have different preferences and constraints.

Final Saving and Investing Quiz

Question

What is the difference between saving and investing?

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Answer

Saving and investing are both money management skills. However, investing differs from saving because it involves various strategies, and you can borrow money to invest.

Show question

Question

What are four types of investments?

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Answer

The four most popular types of investments are:

  • Stocks
  • Bonds
  • Treasury instruments
  • Real estate

Show question

Question

What is the relationship between saving and investment?

Show answer

Answer

Saving and investment are linked at an aggregate level in the loanable funds market. Ultimately, the more savings there are, the more investment there is in the economy.

Show question

Question

How do savings and investment help in economic development?

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Answer

Savings and investment affect economic growth, which indirectly feeds into economic development.

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Question

Is it better to have savings or invest?

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Answer

It depends on your personal preferences. Individuals make distinctive choices about saving and investing because they have different preferences and constraints.

Show question

Question

What is saving?

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Answer

Saving is a habit of setting aside a part of your income at regular time intervals instead of simply spending it.

Show question

Question

What is investing?

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Answer

Investing is strategically choosing to place money where it is expected to generate a return.

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Question

An increase in the aggregate saving causes aggregate investment to...

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Answer

Increase

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Question

Saving and investing are linked at both individual and aggregate levels

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Answer

True

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Question

When you invest in a stock market, you essentially buy a piece of the company you invest in.

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Answer

True

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Question

Generally, bonds are considered a less risky investment than stocks

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Answer

True

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Question

The least risky investment out of the ones listed is...

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Answer

Stocks

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Question

The most volatile investment out of the ones listed is...

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Answer

Stocks

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Question

What is compound interest?

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Answer

Interest on interest!

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