Imagine you’ve just received a £5,000 windfall.
Should you keep it in your current account? Move it to a savings account?
Put it in stocks and shares? Or perhaps use it for property investment?
These questions highlight a fundamental aspect of managing your money: the difference between saving and investing. Despite their importance in building financial security, many people use these terms interchangeably or aren’t clear about when to use which.
At Heathcote Financial Planning, we often find that clarifying this distinction helps our clients make better financial decisions.
Saving and investing both play crucial roles in your financial well-being, but they serve different purposes and involve different approaches to managing your money. This guide will help you understand the key differences, recognise when each strategy makes sense, and show you how they can work together as part of a balanced financial plan.
Saving: Building your financial foundation
Saving is the process of setting money aside in secure, accessible accounts that protect your capital while earning some interest. When you save, you’re essentially preserving your cash for future use rather than focusing on significant growth. The main characteristics of saving include:
Accessibility – you can typically withdraw your money quickly without penalties
Security – your original deposit is generally protected (up to £85,000 per bank, building society or credit union under the Financial Services Compensation Scheme)
Lower returns – typically ranging from 1.5% to 5%, depending on the product and terms
Limited risk – your savings won’t fall in value in nominal terms
Common saving vehicles include easy-access savings accounts, fixed-rate bonds and cash ISAs. They offer different combinations of interest rates and access terms. For example, you might earn 5% in a fixed-rate account that locks your money away for a year, (cashing in during the fixed rate means the policy holder is likely to incur exit penalties), but only 1.8% in an easy-access account.
However, it’s essential to consider the impact of inflation. If prices rise by 3% annually but your savings only grow by 2%, you’re actually losing purchasing power despite seeing the number in your account increase.
Investing: Growing your wealth over time
Investing, on the other hand, means putting your money into assets that have the potential to increase in value over time. Unlike saving, investing focuses on growth rather than preservation, accepting some degree of risk in pursuit of higher returns. The investment market offers numerous options, including:
Shares (equities) in individual companies or through funds
Bonds issued by governments or corporations
Property, either directly owned or through property funds
Exchange-traded funds (ETFs)
More specialised investments, such as venture capital
The relationship between risk and return is the key principle of investing. Generally, higher potential returns come with higher risks. For example, shares have historically provided better long-term returns than bonds, but with more significant short-term fluctuations.
Time horizon is also important. A longer timeframe helps smooth out market volatility, making higher-risk investments more suitable for achieving your long-term goals. For instance, UK equities have experienced periods of sharp decline but have delivered average annual returns of around 5%-7% after inflation over periods of 10+ years.
The power of compound growth is what makes investing particularly effective. If you invest £10,000 and it grows by 6% annually, after 25 years you’ll have about £44,500 – more than four times your initial investment.
The psychology of saving vs investing
Our approach to money is rarely logical. Psychology plays a significant role in how we manage our finances.
Saving often feels comfortable and secure. There’s psychological comfort in knowing exactly how much money you have and that it’s not at risk of declining in value. This security is why many people keep substantial sums in savings accounts, even when inflation erodes their value over time.
Investing, on the other hand, can trigger anxiety because of its inherent uncertainty. Watching your investments fluctuate in value, particularly during market downturns, tests your emotional resilience. This helps explain why some people avoid investing altogether, despite its potential benefits.
Your personal experiences and financial education strongly influence your comfort level with both strategies. People who experienced financial insecurity growing up often prioritise saving, while those familiar with investment concepts may feel more comfortable putting money into the markets.
Understanding these psychological factors will help you make more balanced decisions and avoid letting emotions drive your financial choices. Recognising your natural tendencies is the first step toward developing a more balanced approach.
Understanding what’s at stake
Both saving and investing involve risk, but in different forms.
With savings, the main risks include the possibility that rising prices (inflation) will reduce your money’s purchasing power, and the chance that interest rates will fall, reducing your returns.
With investments, you face additional considerations, such as:
Market risk – the possibility that your investments will fall in value
Liquidity risk – some investments can be difficult to sell quickly without accepting a lower price
Specific risk factors affecting particular companies or sectors you’ve invested in
Your personal risk tolerance – your emotional and financial ability to withstand fluctuations in value – should guide your decisions. Someone approaching retirement typically has a lower risk tolerance than someone in their 30s with decades before they need the money.
Signs you might be taking too much risk include losing sleep over your investments or feeling compelled to check their value daily. Conversely, if your savings are barely keeping pace with inflation, you might be taking too little risk.
When to save and when to invest
Your timeline is the most important factor in deciding whether to save or invest.
For your short-term goals (under 5 years), saving usually makes most sense. In general, savings accounts provide a degree of stability that protects you from market fluctuations that could affect your plans. So, if you’re saving for a house deposit and plan to use it in two years, keeping the money in a high-interest savings account or cash ISA is typically more appropriate than investing it.
For your medium-term goals (5-10 years), a balanced approach often works best. You might keep some money in cash while investing the rest in moderate-risk assets. This approach will provide some growth potential while reducing overall volatility.
And for your long-term objectives (10+ years), investing generally offers better potential outcomes. Your retirement or financial independence goals benefit from the growth potential of investments, with time to recover from market downturns.
Your emergency fund should always be in readily accessible savings, regardless of your other financial goals. This provides financial security and prevents you from having to sell your investments at inopportune times.
Building a balanced financial plan
Rather than choosing between saving and investing, most people benefit from doing both as part of a comprehensive financial strategy. A helpful way to visualise this is as a financial pyramid:
Foundation: Your emergency fund in easy-access savings (3-6 months of essential expenses)
Middle layer: A mix of savings and lower-risk investments to support your medium-term goals with
Top layer: A diversified investment portfolio to support your long-term financial objectives
The exact proportions will vary based on your circumstances. For example, if you’re self-employed, you might need a larger emergency fund than someone with a stable salary. And if you’re approaching retirement, you might want to increase your savings for added security.
Common mistakes to avoid
When balancing saving and investing, several pitfalls can undermine your progress.
Keeping too much in savings during high inflation can erode your purchasing power. Ignoring inflation when evaluating your savings can create a false sense of progress. A 3% return during 4% inflation means you’re losing ground in real terms.
Making emotionally driven decisions during market volatility and not diversifying your investment portfolio across different asset types can also compromise your long-term results. And many people chase higher interest rates or the latest investment trends without considering their overall financial picture, leading to poor timing decisions.
Perhaps most importantly, just ‘setting and forgetting’ the amounts you save or invest each month can fail to account for life’s changes.
That’s why regular reviews of your strategy, with your financial adviser, will help ensure it remains aligned with your goals as you experience significant life events like marriage, a career change or retirement.
How can Heathcote Financial Planning help?
Saving and investing aren’t competing strategies. They’re complementary approaches that serve different purposes in your financial plan.
Finding the right balance depends on your circumstances, goals and comfort with risk. By understanding the distinct role each plays, you can make more informed decisions about where to put your money and when. That’s where we come in.
As chartered independent financial advisers, we can provide clarity on your options, help you optimise your investments and ensure you’re making the most of your available allowances to preserve and build your wealth in the most tax-efficient way.
Book an appointment today to learn how we can help make your money work harder for you. After all, you’ve earned it.
Disclaimer:
This blog is for general information purposes only and does not constitute personal financial advice or a recommendation to invest or save in any particular product. The views expressed are intended to help readers understand general financial concepts, but individual financial decisions should always reflect your own personal circumstances and goals.
The value of investments can go down as well as up, and you may not get back the full amount you invested. Past performance is not a reliable indicator of future results. Inflation may reduce the value of savings over time. Tax treatment depends on your individual circumstances and may be subject to change in the future.
You should seek independent, regulated financial advice before making any significant financial decisions.
Heathcote Financial Planning is authorised and regulated by the Financial Conduct Authority.
Company registration: Heathcote Financial Planning is a trading style of The Mortgage and Protection Partnership Ltd, authorised and regulated by the Financial Conduct Authority under No: 612049. Registered address: Olympus House, Olympus Park, Quedgeley GL2 4NF. Company No: 08734287.