I said I’d come back to saving versus investing. Saving is great but investing is much better. Savings up for a later investment is a very good thing to do. Saving is also useful if you are not yet skilled at investing!
I read something a while ago that said ‘poor people save and rich people invest’. I could understand what the author was trying to say, but actually I believe that ‘poor people neither save nor invest, and rich people do both!’.
What’s the difference between saving and investing?
Saving is the process of accumulating money for future use, this could be to pay future bills, to fund a future purchase or it could be to make an investment in the future.
Investing is the process of buying an ‘asset’ that will generate money for you.
There is a bit of an overlap, you can save and invest at the same time. E.g. if you deposit your ‘savings’ into an interest bearing bank account, you have created an investment, as you are using your savings to generate money – the definition of an investment!
However, as we all know, the rates of interest offered on bank and building society accounts is woefully poor, and so this isn’t really what I’d call a ‘good’ investment. With rates being offered of less than 1%, this is hardly enough to keep up with inflation.
Today, an investment really needs to generate at least 5% return (or 5% interest) to be considered a good investment.
What is an investment?
An investment is something that generates money. Traditionally investments fall into three main categories:
b) Stocks and shares (& other financial investments)
Property: You can buy a house, rent it out. If I buy a house for £100,000 and rent it out for £5,000 a year, I am getting a return of 5% on my investment. I will have some repair and running costs, If these are £1,500 a year then my net return will be 3.5%.
If I buy shares in ‘Vodafone’ for £2.50 and they pay a dividend each year of 20p then I am getting a return of 8%.
If I buy a cleaning business for £1M and that generates a profit of £70,000 a year, I am getting a return of 7%.
Do you see how we can easily assess different types of investment by comparing the rate of return each one gives us. This is a basic concept you need to grasp in order to make good investment choices.
With all of these different classes of investment, there is also another factor. The underlying value of the ‘asset’ that you have bought can go down in value or could possible go up in value. E.g. Property prices generally increase each year over a long period of time, but some years they can fall. Shares that are freely traded on a stock market, such as Vodafone shares, have a price that changes all the time, it goes up and down depending on investor sentiment and confidence towards that particular company, and depending on investors overall view of the economy. The value of a business changes in line with the growth or contraction of that business, it’s size, the number of employees, number of clients, its turnover and its profit figures, etc. So, it is possible to buy and sell assets to try and generate a profit. This is not really investing, it’s better defined as ‘trading’ but can be a good way to fuel your way to wealth and financial freedom.
These three different types of investment are not the only types, but are the main ones. Choose the one(s) that best suit you. I have tried them all. I personally prefer b) at this present time. It’s a personal choice for me. Do what interests and excites you!
If you are going to invest, then you need to educate yourself and you need to start off small as you will make mistakes early on – that’s part of how you get educated!
“Save first, invest later”. To make any investment you need money. To get the money for your investments you should save first. It could take many years to save to buy a property to rent out (of course there are quicker ways to do this…more on that later), but it might only take you a month or two to get enough together to start investing in stock market traded shares. Having cash ready to invest is a great position to be in. There is nothing worse than spotting a great investment opportunity only to find you don’t have the cash to do it!
One of the best innovations to arise out of the internet generation is a relatively new investment concept called “P2P” – “Peer to Peer” Lending. This is basically whereby investors loan money directly to lenders without there being a bank or a middle man involved. Various websites facilitate this. Google “P2P lending”. Look at P2P sites such as Zopa, Ratesetter, Lendinvest, etc.. I like to invest via these sites. I get a decent return on my investment (interest rate) and I can tie up my money for as short a time as one month or as long as five years. (The longer terms pay higher rates of interest).
Investment risks. All investments carry a risk:
Property – I could get bad tenants who don’t pay the rent and who trash the house. The housing market could crash.
Shares – the stock market could crash again, or the company I invest in would go bust or could suffer a decline in profits.
Business – My business could suffer a downturn and lose customers or stop making as much profit.
To mitigate risk, you need to understand the risks, that means educating yourself in whatever area you are thinking of investing. You can also spread the risk. If you are going to invest in the stock market, buy shares in 10 different companies, rather than just backing a single company.
Did you know you are probably already an investor in Property and Stocks & Shares? Yes – if you have a pension fund – this is where your pension fund money is often invested. Find out where your own pension money is invested. In future, as you become familiar with making investment, you may even want to take total control of your pension and decide exactly where it is invested. I’ll tell you my own pension story later…