What is investing?

Many of us have dreams and financial goals for the future. Often, to achieve these, we need to have built financial security. Putting money aside over time is important in achieving this, but there are different ways to do it.

In the animation below, we introduce the basics of investing, how it differs from saving, the role of risk, and how investing can help your money grow. 

What is investing and how does it differ from savings?
 

Investing is one way to grow your money over the long-term and help you achieve your goals.

You can invest in all sorts of things like art and wine, to commodities such as gold. The most common way to invest is by buying shares in businesses. 

When you buy shares, you effectively become a part owner of the company and therefore the economy.  

As the business is successful and its share price rises, the value of your investment will increase. You will have the option to sell your investments when needed, but it’s usually best to leave them to grow over the long term. 

Savings are kept in an account from a bank or building society and you usually receive a higher rate of interest than with a current account. 

Savings are needed for unexpected expenditures, like repairs to your car if it breaks down, and support short-term goals, perhaps a weekend away with friends for instance. 

When compared to savings, investing can potentially provide higher returns on your money, especially over the longer term, for the bigger things you want to achieve with your financial goals.

How compounding can help your returns
 

One of the benefits of long-term investing is compounding. 

This is where you earn returns on the money you make from your savings and investments as well as the original amount invested. 

Compounding helps your money grow faster over time, and the longer you leave it, the more it can grow. And compounding usually has a greater impact on boosting the value of investments than it does on savings, because stock markets tend to perform better than cash over the longer-term.

Understanding risk
 

Investing in shares comes with some risk as stock markets can both rise and fall. This is why investing over a long period of time, ideally at least five years, is important. 

It helps reduce the chance of you losing money because you’ve got more time to recover from any stock market downturns.

Some investments are riskier than others so you should always consider how comfortable you feel about taking risks as this will help with your decisions about where to invest. 

One way to invest which helps to spread the overall risk, is to opt for investment funds. With a fund your money is pooled together with that of other investors and invested across a wide range of companies by the fund manager. The diversification this provides helps reduce the level of risk you’re taking.

If you just invest in the shares of a single company on the other hand, you are reliant on that one business being successful, so it can be quite a high-risk approach to take. It goes back to that old saying of not putting all your eggs in one basket. 

How does inflation impact savings and investments?
 

Inflation is the rate of increase in the price of goods and services, think of how much the cost of a loaf of bread has risen since you were a child for instance, or a cinema ticket. 

The impact of inflation really adds up over time, and means you’ll be able to buy fewer things with the same amount of money. That’s why it’s really important to ensure any returns on your money, whether that’s through investments or savings, keep up with inflation. 

You want to be aiming for a return on your money that is at least equal to the rate of inflation. Ideally you want it to be higher – this is where investing can help. 

Stock markets tend to produce higher returns than savings accounts over the long term, so investing some of your money gives you a better chance of beating inflation.

It’s harder to keep up with inflation rates if you keep your money in savings accounts because the rates of interest are often lower than the rate of inflation. 

Other ways your money can increase in value

ISAs and pensions are popular with investors because they offer a way of investing your money, tax-efficiently. 

ISA

An ISA (Individual Savings Account) isn’t an investment itself but an account that protects your money from tax. There are different types of ISA including cash ISAs and investment ISAs (also known as stocks & shares ISAs).

If you save or invest outside of an ISA, you may have to pay income tax, dividend tax or capital gains tax on the returns you make. However, any returns made on money within an ISA are tax free. 

You can pay up to £20,000 each tax year into an ISA and it’s well worth using as much of your ISA allowance as you can. By doing so, you’ll significantly boost the overall amount you make on your investments over time.

Pension

A pension is another type of investment account which has tax benefits. You get tax relief on money you pay into a pension and any returns you make are also tax free.

Once you pay into a pension you can’t access that money until the age of 55 (57 from 2028).

Is investing suitable for me?

Investing is sometimes perceived as only being an option for wealthy people but you can usually start investing from around £50 a month. 

Investing is best suited for money you can afford you put away for the longer term, ideally at least five years. This is because of the risk associated with stock market fluctuations but the chance of you losing money reduces over time.  

If you have debts, you should prioritise paying those off first and ensure you have enough savings for unexpected costs.

If you’re thinking about investing but are unsure where to start, read ‘How to start your investment journey’, which is available to download from this page. It outlines steps to consider including how to check if a company is regulated and trustworthy to avoid falling victim to an investment scam.  

For more information on how to spot an investment scam, you can use this guide provided by MoneyHelper.