Saving and investing: what’s the difference?
You can be someone who saves diligently, yet you may never manage to accumulate wealth. That’s because there’s a difference between saving and investing. You need to do both, writes Angelique Ardé.
Saving is putting money aside for future use – or spending postponed – whereas investing is what you do with money to earn a return.
This is the view of Steven Nathan, the chief executive of 10X Investments, who says that these different activities are two sides of the same coin, and that it’s important that you do both.
“When you save money for future use, you put money aside with a goal in mind: that may be your annual holiday, your child’s university education in five years’ time, or your retirement, still 30 years away,” Nathan explains. Your objective is to preserve money.
When you invest, your objective is to earn a return – which is to grow your money, he says.
If you hide your spare cash in a drawer, you are saving, not investing. Left alone, that money will not grow in amount or in value; it will lose value.
The constant rise in the cost of living – known as inflation – steadily eats away at the purchasing power of your money. Depositing your money in the bank should at least preserve its purchasing power, but in such a savings vehicle your money won’t grow sufficiently to provide for your retirement, which is why you need to invest in assets that deliver a high real (after-inflation) return over time. A tried and tested way of doing this is in higherrisk assets such as shares, which may prove volatile over the short term, but deliver inflation-beating returns over longer periods.
This is an important message for people who are good savers but poor investors.
Financial planner Natasja Hart says she has come across such people, who have “saved themselves poor” – meaning that they have failed to invest. “I’ve seen it with older people who tend to derive comfort from having easy access to their money in the bank.” But left in the bank, their money has hardly grown and they have lost the opportunity for gains to compound over time.
Nathan says that when you save your money as cash in the bank, the risk is generally very low. “You therefore earn a return that, over long periods, exceeds the inflation rate by only one percent a year. But you can be almost 100-percent sure that when you draw your money, you will receive all that you put in plus any interest that is due to you.”
Share prices, on the other hand, move daily. “You are thus never sure how much money you will receive for your shares until the day you sell them. However, to compensate for this uncertainty, you are likely to earn a real return of six to seven percent a year from a well-diversified share portfolio that is held for many years.”
But how will real growth of six percent a year fund your retirement, you may ask. Nathan says that it works through the phenomenon called compounding.
“Say you deposit the price of a loaf of bread today into an investment account that grows at five percent a year in real terms (six percent a year, net of an annual fee of one percent). After 15 years, your investment should pay for two loaves of bread and after 40 years seven loaves.”
This is the effect of compounding, or earning a return on your return. The longer you invest, the stronger the compounding effect becomes.
Nathan says that the key lesson here is that you should start investing as early as possible, to benefit from the strong compounding effect by the end of a long investment term.
“If you invest your money in the bank, earning a real return of one percent a year, you will be able to buy only a loaf- and- a- half in 45 years’ time. In other words, even if you invest diligently over your entire working life, investing in a low-risk asset class could curtail your standard of living in retirement. That is a much bigger risk than exposing your money to the share market over the longterm,” Nathan says.
He says there tends to be an over-emphasis on saving, when we should be considering long-term returns.
We’re repeatedly told that South Africans are a nation of spenders, not savers. Yet a significant number of South Africans are saving by way of regular contributions to retirement funds, unit trusts and stokvels, Nathan says.
Almost 11 million people in South Africa contribute to a retirement fund and these funds have assets worth about R4 trillion. And about 11.5 million South Africans belong to one or more of the 810 000-odd stokvels, which are custodians of an estimated R49 billion. The number of savers excludes the unknown number of investors in the local unit trust industry, which is worth about R2 trillion.
“Stokvels are an interesting phenomenon – there’s one in our office. A bunch of people put in R200 a month, and every month someone gets R2 400. It’s a good mechanism for disciplined saving towards a short- term goal. The loyalty is high and the peer pressure is there to stop anyone from missing a payment.
“But a rand in a stokvel is always worth a rand. You want a rand to be worth more – and that’s the difference between saving and investing. But you need time on your side,” Nathan says.
Alexander Forsyth- Thompson, the head of stokvel investments at Investment Solutions, says stokvels that accumulate money in cash or in the bank have a real opportunity to put this money to better use.
“Investment and burial stokvels are accumulating large sums of money that are severely diminished by inflation when left in cash or the bank,” he says. If groups such as these ( only four percent of stokvels are “investment” stokvels) put their money into the right investments, members may have seen their money double, triple or quadruple over longer periods of time, he says.