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Why it’s important to have savings and investments

Having money set aside gives you freedom as well as financial security. It means you can book a holiday without worrying about getting into debt, and also gives you a safety net for unexpected events such as the boiler breaking.

The general rule of thumb is that you should have at least three months’ worth of living expenses in easily accessible savings. Some recommend setting aside as much as six months of income. This protects you if you lose your job or are too sick to work. It means that you’ll still be able to pay your rent or mortgage, keep up with bills and put food on the table.

Alongside these emergency savings, you might also want to set aside spare cash for future goals. This could be a wedding, a holiday, or even Christmas spending. 

The nature of these aims, how far in the future they are, and your appetite for risk will determine whether this money is best saved or invested.

Generally, setting aside 10% of your wages each month is good practice, if you can. You can split this between different goals, and you might choose different financial products for each. For instance, you might choose to top up your pension, save for a dream holiday, and set up an ISA for a house deposit.

When not to save or invest

There are some circumstances where it might not make sense to save. For instance, if you have expensive debts, where the interest is higher than you would earn in savings interest or investment returns, then you should tackle that first. 

Here’s what to do:

• Start by listing all your outstanding debts

• Work out which debt costs you the most

• Consider consolidating debts into a lower interest arrangement 

• Pay off the debt with the highest interest charges first

Check if there are any restrictions on whether you can repay each debt early, as some fixed term arrangements come with hefty early repayment charges.

If you have cheap debt, for instance a 0% credit card, it might make sense to save the money in the highest interest paying account that you can, and then clear off the debt when the 0% period ends.

Equally, if your mortgage rate is high, you may find you’re better off overpaying that than building additional savings or investments beyond your emergency fund. Some mortgages charge a penalty for you to overpay more than a certain amount each year, so check your documents or ask your provider. Most mortgage providers will allow you to overpay up to 10% of the remaining balance per year without incurring a fee. 

Even if your lender does charge a fee, it may be worth comparing this with the amount of interest you stand to save by making a large payment.

If you have no debts but think you will still struggle to save, using a budget planner may help you to see where you can cut costs.

What’s the difference between saving and investing?

Saving and investing are both ways of trying to make your money work harder, but there are important differences.

Saving

When you save, you deposit your money with a bank or building society, and in return it pays you interest. For instance, a bank might agree to pay you 5% of everything you set aside each year. The amount of interest is generally agreed in advance and could be either fixed or variable. 

If it’s fixed, you’ll know exactly what you’ll earn over the course of the year. Variable interest might change, for instance, if the Bank of England changes its base rate. Your provider must tell you if it is putting rates up or down.

When you save, your capital (the amount you put in) is not at risk. You’ll get back all your original savings, plus any interest. You should choose savings accounts that pay more than the rate of inflation. 

If you don't, over time, the cost of goods will rise more quickly than your savings and your purchasing power will be eroded. So, you need to save more than expected to meet your financial goals.

The best accounts currently available pay well above the rate of inflation.

Investing

There are lots of different types of investments. These include:

• Stocks and shares

• Bonds

• Funds

• Property

• Government bonds

• Fledgling businesses 

When you invest, you’re buying assets (or shares of assets). These could be anything from stocks in Google to office buildings. The hope is that your investments will increase in value over time, so that you make a profit when you sell. 

You can also take a share of any profits the thing you’re investing in makes - known as dividends when it comes to stocks. Some investment strategies focus on this aspect, aiming to generate an income by buying shares in companies that pay dividends.

Of course, the things you buy could sometimes decrease rather than increase in value. If you sell after a stock has dropped in price, for example, you could end up with less than you put in. 

To protect against this, most investors choose not to buy single stocks in just one company or asset, but instead to diversify across a wide range of assets. This helps to protect your portfolio from volatility (the ups and downs of the financial market). There are plenty of companies that will do this for you, either by actively picking a range of investments, or by mimicking one of the financial indexes, such as the FTSE 100.

While investments can be risky, especially in the short term, well diversified strategies typically outperform savings rates over the long term, helping to protect your money from inflationary rises. Most people have some form of investment – as pension schemes are invested in this way.

When to save and when to invest instead

Deciding whether to save or invest all depends on what you want to achieve, when you want to achieve it, and how you feel about risk.

Short, medium, and long-term goals

The first thing to consider is whether your aim is short or long term.

If it’s something soon, such as a holiday next year, then you should save. Experts recommend that people investing only do so if they can afford to wait at least five years before accessing their money. This gives you time to ride out stock market volatility and time for your investments to bounce back from any falls.

However, if your goal is very long term, for instance for retirement, you should definitely think about investing. All workplace pension schemes in the UK are invested, and it’s the best chance of using compound interest to grow your money and beat inflation. 

If you’re setting aside money for a medium-term goal, such as buying a house in ten years, then whether to save or invest mainly comes down to how much risk you’re prepared to take.

Appetite for risk

Your appetite for risk is another way of saying how cautious or adventurous you are. Some people are happy to leave their money in savings even if it will be eroded by inflation, because they don’t like the risks associated with investing.

Others prefer to give their money a chance to grow more over time and are willing to take a chance on investments they think can achieve this.

Even among those who invest, risk appetites vary. Some people prefer to invest in more volatile, high-risk stocks in the hopes of making greater returns. Others prefer to invest in assets that are more stable, so are less likely to make massive returns, but also less likely to drop in value.

The advantages and disadvantages of savings and investments

What’s the best way to save money?

Easy access savings

These accounts let you access your money whenever you need it, making them a great choice for emergency savings. The best accounts offer similar rates to notice accounts, so you can use them for longer-term goals.

Learn more about easy access savings accounts

Notice account savings

To access your money in these accounts you need to give notice, for instance 30 or 60 days. They no longer tend to pay better rates than easy access accounts  and you won’t be able to get the cash quickly in an emergency without paying a penalty.

Learn more about notice accounts

Fixed rate savings accounts or bonds

Here you offer to lock your money away for a set period, for instance one, three, or five years. In return, you sometimes get higher interest rates and the interest rate won’t change over the fixed period. These accounts can therefore be good for medium-term goals.

Learn more about fixed rate savings

ISAs

Cash ISAs allow you to save money without paying any income tax on the earnings. However, basic-rate taxpayers have a savings allowance worth £1,000 each year, meaning most people don’t need an ISA unless the rate is higher than a traditional account. For higher-rate taxpayers, or those with big sums saved, these remain a valuable tool to reduce tax. 

You can also get cash lifetime ISAs. The government pays you a 25% bonus on savings up to £4,000 each year, as long as you use the money saved for either a first home purchase (within the guidelines) or for retirement after 60.

Learn more about ISAs

Regular savings accounts

Some accounts offer you a higher interest rate if you save a certain sum each month. These are often linked to current accounts and can pay market-leading rates. You might have to agree not to remove any money for up to a year or two, and you will be limited in how much you can save.

How to maximise interest

The best way to do this is to find the highest interest rates you can for your money, balanced against the amount of access you need. Savings linked to bank accounts often pay higher than average rates, so check what your bank offers and consider switching for better accounts. 

Regular savers are also usually good value but limit how much you can save – so having several is a good way to maximise earnings. If you can afford to lock your money away, meanwhile, check fixed rates as these may be higher than easy access options. 

Learn more about regular savers and linked savings accounts

What’s the best way to invest money?

Pensions

If you’ve got spare cash, investing it into your pension is a great way to safeguard your future. Even better, the government will give you tax relief at your marginal rate (the highest rate of income tax you pay). Some employers offer contribution matching so the more you save, the more they pay in – another helpful boost.

Learn more about pensions

Stocks and shares ISAs

When you invest in stocks and shares ISAs, any returns you make are free from tax, which can make them one of the best ways to invest money. Choosing the right ISA provider is key. Things to consider include costs and fees, whether they will choose investments for you based on your risk, and the range of investments available.

Learn more about S&S ISAs

Platform investing

If you’ve used up your ISA allowance, and you don’t want to lock money away into a pension, investing via a platform is usually the cheapest way to access the stock market. You can choose a DIY option, where you pick the stocks and shares yourself, but you should only do this if you have a good knowledge of the stock market and are willing to put in a bit of time and effort. There are also plenty of robo-advised options, where you tell the platform about your appetite for risk and it picks a diversified fund (or funds) for you.

Share dealing

Share dealing is when you buy and sell shares in publicly listed companies using a stocks and shares account. You are buying shares in individual companies,  rather than investing in a fund (a basket of shares) or passive investment that tracks an index.

The idea is to buy shares now that you can later sell on for more. The company sets the initial price, but then it is affected day by day as people buy and sell based on factors such as the economy and the individual company’s performance.

The risks can be high as you’re essentially trying to predict the company’s future performance. That’s why you should try to diversify your investments where you can.

Asset investments

Some people like to invest in things they can physically own such as art, wine, whisky, gold bullion or even cars. Do your research before investing in any asset, particularly around whether there are rules around how things must be stored.

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Investing in property can allow you to make money in several ways, including renting out a house or flat to earn an income and renovating properties to sell them on for a profit.

There are costs to consider, though. If, for example, you rent out the property, you’re taking on the responsibilities and expenses of becoming a landlord, which could end up costing you more than you think.

And if you don’t have the cash to buy a property outright, then you’re likely to need a buy-to-let mortgage.

You may therefore prefer to invest in property by pooling your money with other people in a property investment fund. Real estate investment trusts, for example, can be bought into relatively cheaply, and distribute 90% of the money they make in rents back to investors.

Find out if you have what it takes to be a property developer

How to reduce risks

Diversify your investments as much as possible, which means looking at different companies, industries, regions of the world, and asset classes. To get high returns, you’ll typically need to take more risk. But you should always only invest at the level you’re comfortable with. 

Check your portfolio and make sure you consider costs and charges carefully. But don’t panic if your investments fall; volatility is an important part of investing. Selling just because your shares have gone down may mean you lock in those losses unnecessarily. However, if a share is consistently underperforming, don’t be afraid to get rid of it. 

Consider choosing a platform or provider that will make investment choices for you if you’re not an expert. You may wish to seek financial advice before you make any decisions. 

Speak to an IFA

If you’re unsure which option is the best choice for your circumstances, speak to an independent financial adviser (IFA).

An IFA will look at your finances in detail. They will recommend a selection of investment options that are well suited to your goals and circumstances.

Here is how to find an IFA you can trust