As I have learned about investing and speak to others about it, I often notice people using saving and investing interchangeably.
To me, there is a big difference between saving and investing.
People often ask me how they can start investing. They know investing can make their hard-earned money grow.
I always ask them two questions:
- Can you avoid spending the money for the next 5-10 years?
- Are you willing to lose it all?
These two questions help me decide whether people should invest or save their money.
How I think about investing vs. saving
As a former consultant, I love to simplify things by putting it into a 2 by 2 matrix.
When it comes to investing and saving, this is not an exception:
The matrix helps me decide whether people should save or invest. It all comes down to time horizon and risk. Naturally, you can place your cash in multiple quadrants at the same time.
When should you invest?
In my opinion, the only time you should invest in high-risk assets is when you don’t need the money for the next 5-10 years and are willing to lose it all. High-risk assets are stocks (through index funds or not), crowdlending, cryptocurrencies etc.
That’s right, I don’t think people should invest in stocks if they can’t confidently answer “yes” to the two questions above.
If you need the money within the next 5-10 years, you probably shouldn’t invest in high-risk assets such as in P2P lending platforms such as Mintos or Envestio. If you are not willing to lose your investment, then don’t invest either.
What if you can only answer “yes” to one of the questions?
If you can only answer yes to one of the questions, you either have to spend the money in the next 5-10 years or you are not risk-averse.
In this case, you could consider investing, but not in high-risk assets. I consider, for example, bonds and property, to be low-medium risk investments.
When I say bonds, I don’t mean junk bonds to junk companies in high-risk countries. I’m talking about government bonds in developed and safe countries.
When I say property, I don’t mean speculative investments where you expect the price to increase. I mean the ones that generate passive income with all expenses included and a buffer for tenant vacancies.
If you are more risk-tolerant, I would go for properties. If you are more risk-averse, I would go for bonds.
Should you never invest if you are risk-averse and need to spend the money in the next 5-10 years?
In many cases, I find out people actually want to save and not invest.
Most people need to spend their money in the next 5-10 years. People save up for vacations, weddings, birthdays etc., and to me, this is saving for future spending.
Most people turn out to be risk-averse when you ask them if they are willing to lose it all.
I often encourage people to think differently about investing before making up their minds. It often requires a mindset change to get started investing.
Personally, I would always pay myself first by automatically transferring an amount for investment each month. I try to find the largest possible amount I am willing to lose and don’t need to spend soon and invest it in high-risk assets. By doing this, I have become more risk-tolerant over the years.
That’s why my number one tip for people who find themselves in the bottom left quadrant is to just start investing small amounts to get comfortable investing. However, of course, people should never invest more than they are willing to lose.
For the amount of money you place in the bottom left quadrant, you could consider investing it in a low-risk investment such as government bonds.
When you should save and not invest
If you are not comfortable investing at all, your last option is to add them to your savings account or CD – or even stuff them under your mattress.
If you have a short-medium time horizon and low risk appetite, saving is the best option for you in my opinion.
To me, saving is currently a bad option for three reasons:
- Some banks around the world have started charging negative interest rates given the current economic environment. This means you pay to have your money in the bank.
- In the current environment, the interest rate is often lower than inflation, so the value of your money is eroded over time.
- The opportunity cost of not investing means you give potential returns while not investing
This being said, I don’t want to push anyone into investing if they are not comfortable doing so.
Whether you choose to invest or save, I don’t care. To me, it’s just important that you make your decisions about whether to save or invest knowing the pros and cons.
Your turn: How do you think about investing vs. saving? 🙂