A prominent question when planning finances is whether you should save or invest your money.
While saving means putting away cash for future use, investment involves purchasing assets which will yield good returns in the future. These assets include, but are not limited to, shares, property, mutual funds, and bonds. Usually, people save for emergencies or to purchase items that they can’t currently afford.
Tip: To avoid temptation, ensure that your savings are automated.
Justmoney spoke to Jan van der Merwe, head of actuarial and product at PSG Wealth about the factors that help you differentiate between the two options.
Time is of the essence
Van Der Merwe says you must think of savings as putting money away with a short-term view. Investing, on the other hand, is a long-term exercise where you aim to grow the real value of your money – in other words, its buying power.
Investing is aimed at keeping pace with inflation over time. Cash can’t keep up with inflation, especially when you look at it over the long-term.
According to Van Der Merwe, cash or cash-type investments can be a good option if you save for a shorter period or need to plan for significant cash flows related to specific expenses.
“If you want to save for two years, you might consider saving in an easily accessible bank account that earns you some interest, or you might invest in a unit trust where there is slightly less volatility, such as in a money market fund,” he says.
However, if you have more time – that is five years or more – putting money towards your retirement, and investing in a good pool of growth assets, is likely to give you a better outcome over the years than just keeping your cash in the bank.
What are the risks?
The risks depend on your time horizon and asset exposure, says Van Der Merwe.
“Saving in a bank account is like holding on to cash in an account instead of in your wallet,” he says.
As inflation creeps up, you won’t be able to buy the same items if your cash isn’t growing.
Growth assets, such as shares, tend to outpace inflation in the long-run, but they can be volatile – and you may see the value of your investment decline in the short-run.
Van Der Merwe says you need to understand this risk and find a balance between the different types of assets that work for you.
He says it’s best to have both easy access to cash funds to help with unforeseen expenses and long-term funds that can grow more aggressively to help secure your financial future.
Can you access your money easily?
According to Van Der Merwe, you need to consider whether the financial products you’re invested in will give you access to your money at any time.
There is a wide array of financial products available, and each has its advantages and disadvantages.
“While ensuring the long-term growth of the assets in your portfolio is key, so is having a portion of your investments in easily-accessible investments to cover unforeseen expenses,” says Van Der Merwe.
For instance – if you choose a retirement annuity (RA), you won’t be able to easily access your funds until age 55, unless the capital amount is under a certain threshold or you’re emigrating. Other investment products, such as a unit trust have more flexible access.
Are there minimum or maximum contributions?
The amount you need to save or invest will depend on the product you’re using and what you’re putting money aside for. For instance, saving in a bank account might not have any limit, says Van Der Merwe.
However, when you’re investing, there could be a minimum monthly amount that you need to contribute.
He advises not to get discouraged by a minimum monthly requirement.
Once you get started, you can also pause contributions and allow your investment to earn interest on itself, which continues to grow. This is called compound interest.
According to Van Der Merwe, there may also be maximum contributions to keep in mind when investing which are in line with tax efficiency.
“With a TFSA, you can only invest R500,000 in your entire lifetime with R33,000 as the cap per year, and investing more in this product attracts very high tax rates,” he explains.
In an RA, you can invest up to 27.5% of your monthly income – up to R350,000 per year – tax-free. You can invest more without penalty, but you’ll pay tax. Plus, you can also make additional lump-sum contributions if you want to, he adds.
The returns you can expect
The mix of assets you invest in will determine the eventual return you can expect.
While the return of cash-type investments tends to be more predictable, the return from growth assets tends to be more uncertain in the short-run, but higher over time.
The best option for you will depend on your investment objective, timeframe, willingness, and ability to accept the risks that come with investment, says Van Der Merwe.
He says that sticking with cash might be the best for a shorter period return because you won’t lose any of your actual capital.
To speak to an adviser who can help you choose the best investment options, click here.