Week three guys, wow, where has the time gone lol. So lets’ recap.
- At this stage, we should now have a good understanding about what our money is doing (make sure you check out The five essential steps to managing your money better blog post) and we have created a budget as a result of that exercise.
- Next, we evaluated our financial goals and we put that down on paper (make sure to check out the Let’s start moving towards financial independence – Set your financial goals blog post).
Now that we have everything in order, the next big question is, what do you do with the money you have set aside to help meet your financial goals. Do you save or do you invest? Regardless of your answer at this stage, the aim of both is to essentially grow your money.
The main aim of saving is to put money aside, usually for something specific like a holiday or a house etc. So you are taking your physical cash and putting it away (might be under the bed or in the bank 😊) but the idea is that it is available when you need it, and compared to investing, there is a low risk of your savings losing its value.
Nevertheless guys, don’t be fooled, savings aren’t entirely “risk-free”. Why? Well, it has something to do with interest rates (a percentage charged on the total amount you save). So first of all, if you want to save your money and you want to watch it grow, it’s probably better to stick it in a bank rather than under the bed 😊. If your bank has high interest rates, then the money you save will likely benefit from this, however if interest rates are low, then the return you will get on your money will be very modest.
High interest rate
Bank of Simplyseyi is offering 4.5% on your savings account.
You save £5000 in your account over 12 months.
The amount you have in the bank after 12 months = £5000 + ((4.5/100) x 5000) = £5225
Low interest rate
Bank of Life is offering 1.5% on your savings account.
You save £5000 over the course of the year.
The amount you have in the bank after 12 months = £5000 + ((1.5/100) x 5000) = £5075
So, whilst your money is relatively safe in the bank, the growth overtime can be very slow compared to when you invest.
This is also similar to savings in that you are also putting money aside, however, the difference is that you are not putting your money into a bank account where it just sits, but rather, into something that you believe will go up in value over time. The most common example is shares/stocks and when you purchase a share/stock, it essentially means you own a proportion of the company in which you bought the shares/stocks.
Now here comes the “scary” bit that everyone already knows about, but sometimes don’t really know why. With investing, you are exposed to a higher level of risk than when you save your money in bank account, why? Well, because there is a potential that you could lose the initial money you started with to invest and this simply means that the value of your investment can and will jump around, so you could get back less than what you put in. However, did you know that there are different levels of risk? Not all investments are high risk and there are some low risk investments you could invest your money in to get a comfortable return.
So, what is high risk and low risk investments? In my humble attempt to answer this, we first have define risk, and simply put, risk is something unwanted happening.
Therefore, a high-risk investment is pretty much when there is a high likelihood that you could lose the money you have invested. So why do people even think about doing this? Well, the upside to this kind of investing is that you tend to gain a lot of return on your investment.
Some experts recommend that you should aim to invest for a minimum 5 years or more because the longer time-frame allows your investment to grow, or if not, at least recover if it falls in value.
Whereas, a low-risk investment is where you have evaluated and concluded that the chances of losing some or all of your money is low. So, you find that there is a form of security with this type of investing.
- Earn interest on your savings
- Saving accounts are free to open in the UK
- You have easy access to your money
- You are able to reach your financial goals as long as you stick to your plan because your money is not affected by outside influence
- Inflation, so if bank doesn’t pay a competitive interest rates, inflation could be eating up the value of your earned interest
- Interest rates can change. So you may sign up to a bank that was offering a high interest rate but they have the power to change that, so be aware
- The ability to access your savings at any time may increase the temptation to spend it
- You have the potential to get higher returns than if you were to save
- As a result of the higher returns, you may not have to contribute as much money or time in order to reach your goals
- You are able to build wealth over a long period of time, if done strategically
- Your investment could decrease in value
- You could potentially lose the money you initially put in
To conclude, I thought I would share with you a rule of thumb we have adopted in my house, which is to save for what is around the corner and invest for the future.