What’s the best way to grow your money? Is it the steady, reliable route of a savings account? Or could the more lucrative, but riskier path of the stock market be for you?.
I remember when I first started working. I saved every penny I could, hiding it away in a bank account. It was what I had been taught to do, it felt right. Years later I realized how inflation was silently stealing my savings. Regardless of the interest I had made, I had effectively lost money over time.
Imagine two scenarios: one where your money sits quietly in a bank account, slowly accumulating interest. Another where it’s actively working to grow, making more money for you, multiplying over time. Which path leads to true financial security? The answer lies in understanding the difference between saving and investing.
- Saving:
- Investing:
- Saving or Investing?
- Compounding with Savings:
- Compounding with Investing:
- The Results
- The Conclusion
In this article I will examine the key differences between saving and investing in the stock market. I will cover advantages and disadvantages, as well as obtainable returns. We often have the same goal in mind when we talk about saving and investing. Creating wealth. Lets look at some of the key advantages and disadvantages with saving.
| Feature | Savings Account | Stock Market Investing |
| Risk | Very low (FDIC Insured) | Moderate to High |
| Return Potential | Low (Struggles with Inflation) | High (Historically Outpaces Inflation) |
| Accessibility | High (Normally Very Easy Access) | Low (Fee’s can be charged, assets must be sold) |
| Time Required | Low | Moderate to High (Depending on Investment Strategy) |
| Passive Income Generated | Low | Moderate to High |
Saving:
While savings are useful for saving for short term goals, they are ineffective when trying to build wealth. Their gains are often stumped by inflation due to their low interest rates. They are still extremely important. Savings can provide a much needed buffer for unseen expenses or sudden changes in income.
Imagine your job lets you go out of the blue. Savings can give you time to take a couple of months off and find a job you enjoy. Rather than just applying to every job out of desperation. It is often sensible to have 3-6 months expenses in savings where possible. Now lets take a look at the advantages and disadvantages of investing.
Investing:
Investing excels in growing wealth in the long term. Investing can let savings compound at faster rates than in a traditional savings account. It gives greater control of what your money is used for. You can use it to fund causes you believe in, companies you love. It is the first step in many towards financial freedom and passive income. Investing returns are commonly higher than that of a traditional savings account.
Investing does come with disadvantages of its own. Where a savings account will guarantee your interest rate. The interest rate of stock market investments are dependent on market fluctuations, making it unreliable. Investing is also not very liquid. To get cash for expenses from investing, you often have to sell assets. Usually coming at an additional cost and taking time to withdraw your money.
Saving or Investing?
Ultimately investing and saving both have their places when generating wealth. Savings should be used as a buffer when saving for short term goals.
This buffer is useful to save you from selling assets at less opportune times due to unseen expenses. Investing if great for long-term wealth generation, due to higher interest rates, long term investing can generate some impressive wealth. We are about to see just how savings and investing compare when put to the test of time.
Compounding with Savings:
Imagine we are saving for a house. Every month dedicating some of our hard earned cash to a fund we don’t touch. Storing it away in a savings account for when the day comes we eventually have enough for a deposit.
We scour the internet, looking for a savings account we can access regularly, with a competitive interest rate. We choose an account with a popular bank, a standard saver we can withdraw from at any time. As we are going to save our money over many years, we will ignore introductory interest rates. Our interest rate for the first 6 months is 4.8%. After these 6 months this rate could decrease.
For the calculations in this scenario we are going to assume it stays the same. Each year inflation is slowly eating away at our savings. Inflation makes the value of our money less. £100 at the beginning of 2023, with an annual inflation rate of 2.5% would only be worth £97.50 at the beginning of 2024. While the numbers in our savings account do not change, the value in the real world does.
With our 4.8% interest rate and our 2.5% rate of inflation, we are earning about 2.3% per year on our savings. We have already saved a reasonable amount of money, £10,000 towards our house deposit. We are not going to contribute any more to this. We will purely see how the money appreciates in the savings account for the first 10 years. See the results at the end of every year below. Please note the savings value is calculated as the value of the money in 2024. With no interest applied for the first year.
- £10,000
- £10,250
- £10,506.25
- £10,768.91
- £11,038.13
- £11,314.08
- £11,596.93
- £11,886.86
- £12,184.03
- £12,488.63
At the end of our 10 years, we have earned £2,488.63 in REAL interest in our savings account. While this does compound every year, the savings rate is low, meaning it does not grow much over time. As well as this, our interest rate in a savings account is likely to fluctuate with the economy. Poor years for economic growth can result in reduced savings rates. Meaning over a longer time span like 10 years, the rate our savings compound is not guaranteed. Let us take a look at how investing compares.
Compounding with Investing:
Let us use the same scenario as before. We will assume a 2.5% interest rate as before. Yet again we will start with £10,000. But this time, we are going to see what would happen if we invested the money in the stock market.
Many investors frequently see annual returns close to 20%. It is a very achievable return, but we want to create a conservative estimate for our investment. For our interest rate, I am going to use 10%. A very achievable interest rate with low-risk investments in the stock market. All of which requiring minimal management. After reducing the interest rate for inflation, this leaves us with a 7.5% return each year.
We are going to assume we are managing the portfolio ourselves, therefore paying no management fees. We will still need to pay transaction and currency conversion fee’s. We will assume we are paying a 0.15% fee for currency conversion, and a 0.7% deposit fee. For a total reduction of 0.85%. Leaving us with £9915. Let us see how this compounds over 10 years.
- £9,915
- £10,658.63
- £11,458.02
- £12,317.37
- £13,241.17
- £14,234.26
- £15,301.83
- £16,449.47
- £17,683.18
- £19,009.41
At the end of our 10 years we have made a total of £9,009.41 in REAL returns. Nearly doubling our initial investment. Of course this is assuming we make at least a 10% return every year. While many investments aren’t this reliable, and it is possible we could end up losing money or making lower returns. 10% is a very achievable estimate for the beginning of our investing journey. So lets see how the two methods compare.
The Results
With saving we made £2,488.63 (adjusted for inflation). With investing we made £9,009.41. An increase of £6520.78, over half of our original investment. This demonstrates just how powerful investing can be compared to saving over a long time period.
While investing can be risky and it is possible to lose money. Many precautions can be taken to mitigate this risk. With a well managed portfolio, there is no reason you can’t earn 10% or more annually.
On average over the past decade the popular index fund, the S&P 500 has had an annual return of 13.31%. 10 years ago if you didn’t want to pick stocks to invest in yourself. You could have invested directly into the S&P 500 and made more interest than our scenario. This shows just how achievable the 10% annual return can be.
The Conclusion
The decision between a savings account and the stock market boils down to a fundamental trade-off: safety versus growth. While savings accounts offer peace of mind and easy access to your funds. They often struggle to keep pace with inflation.
The stock market, on the other hand, offers the potential for significantly higher returns but comes with greater risk. Understanding this trade-off is crucial for making informed financial decisions.
Ultimately, both are required when generating wealth. Savings can help pay for unexpected expenses or lack of income. Preventing you from having to sell investments at bad times. However, when generating wealth over a long time, investment is crucial. The greater possible interest rates will quickly compound your wealth. Leading to a truly financially free life. Although it is more risky, this can be mitigated by using good investment strategy. Have a look at how diversifying your portfolio can mitigate risk here.
On this blog we will delve into other investment vehicles, risk management strategies, and retirement planning in future posts, so be sure to follow our blog for more valuable insights.
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