Context

Imagine being debt free and having earned £100,000. What do you do with it? You know that keeping the money under a pillow will unlikely yield productive returns with inflation clawing away at its real value over time. What about putting the $100,000 to work and growing your wealth?

Welcome to the world of saving, investing, and trading – the three main ways for putting your money to use (besides spending it of course). Each involves different levels of risk and expected return. The strategy you pick will depend on your goals and risk appetite.

This Article will explain each of the options above and provide you with insight on how to better allocate your hard-earned cash.

 

Saving

Saving, at its most fundamental level, is simply setting aside money to cover futured planned or unexpected expenses. Since £100,000 is quite a large sum of cash, it is unlikely that the piggy bank you have at home will have sufficient storage capacity. In that case, you may wish to consider a savings account. Savings accounts will pay you interest to keep your money with them. If the interest rate is higher than inflation, you will continue to generate positive real returns with the value of your assets continuing to grow.

If you are interested in opening a savings account, do speak with your banking representative in selecting one that is the best fit for you. At a basic level, an easy-access savings account will let you make unlimited withdrawals whenever you want. However, these accounts come at the expense of lower interest rates. Alternatively, a fixed-rate account will lock your money away for an agreed period in exchange for higher interest rates.

If you are interested in purchasing your first home and are based in the UK, you may consider the  ‘Help to Buy ISA’. This special savings account allows you to save up to £200 each month. The government will then top up your savings by 25% upon the successful transfer of legal title.

However, it is noted that savings accounts are not perfect. With an interest rate of in or around 2 per cent per annum, your £100,000 is unlikely to grow at a rapid pace. Should you desire stronger returns in the medium term, consideration ought to extend to investing or trading.

 

Investing

Whilst investing may seem complicated, the core idea is relatively simple: It is about putting your money into assets that you reasonably expect to increase in value over a specific time horizon. The options for what you can invest in are truly limitless but popular choices include real estate, commodities, equities (i.e. stocks) and fixed income (i.e. bonds).

New investors often purchase shares at their favourite corporations such as Apple or Amazon. If you purchased 1 share of a company at £100 on 1 January 2018 and sold that share for $175 on 31 December 2018, you would have made a profit of £75 or a 75 per cent return on investment! However, by investing in just one company, you risk putting all your eggs in one basket as there is no diversification. If share prices falls, whether it be due to idiosyncratic or systemic risks, your investment could be wiped out.

In that case, it may be wiser for new investors to consider investing in a fund. A fund is a basket of shares in different companies. By investing in a fund, you will be able to diversify your money into multiple businesses in a single click. Investing in Exchange Traded Funds or ETFs is perhaps the best way to get started.

If shares of a company do not interest you, consider bonds. A bond is just a debt security whereby the bond holder lends the issuer money in return for regular interest payments or coupons. Whilst bonds tend to offer smaller returns than equities, they are also generally more stable and your initial payment will be returned to you upon maturity (i.e. the end of the bond’s term), save the issuer entering default.

In short, investing is about making informed decisions about the future. Famous investors, such as Warren Buffet and Charlie Munger swear by value investing. At the danger of being overly simplistic, value investing is about researching a company with strong fundamentals, purchasing them when their prices are unjustifiably low with reference to their intrinsic worth, and leaving the cash there for as long as possible. With time, your investments should grow healthily.

If investing remains unable to satisfy your appetite, enter the world of trading.

 

Trading

If savings is akin to progress at a snail’s pace, investing would be a slow and steady turtle, and trading would be a hare. It is a high-risk, high-reward strategy. The biggest difference between trading and investing is timeline.

Investors will typically spend many hours researching company fundaments from quantitative perspectives such as cash flow and debt-to-equity ratio to qualitative perspectives such as business model and competitive advantage. Investors will typically hold onto their assets for years, if not decades.

Conversely, traders are not overly concerned with what they are trading. Instead, traders are more concerned with buying an investment, with currencies being the most popular medium, and quickly selling it for a profit when the price goes up. In other words, traders are more concerned with short-term market movements. In the UK, traders may speculate on the financial market by engaging in Contracts for Differences (‘CFDs’) or spread betting rather than purchasing the investments directly.

But trading generates the opportunity to bring in significant returns in a very short space of time. It may even be possible, as a matter of example, to quadruple your initial investment amount in the space of an hour if you are very lucky. But with the possibility of such returns is a corresponding high level of risk. This means it is also possible to lose your entire initial investment, especially if you engaged in leveraged or margin trading for borrowing money to increase the size of your bets. As such, the line between trading and gambling can become remarkably blurry since there is invariably a level of speculation on the asset’s short term price movements.

There is one other risk worth mentioning for the uninitiated trader. Trading is a game of speed. Professional traders often spend millions to acquire special high speed cables connecting them to the stock exchange just so they can trade a micro, nano, and even a picoseconds quicker than you. Moreover, professional traders may also employ program or system trading which uses complicated algorithms to rapidly process data and make trade decisions without the hindrance of human emotions.

 

Concluding Remarks

In deciding whether to save, invest, or trade, you must understand your financial goals and risk tolerance. You may elect for low risks, good returns, or a short time horizon, but certainly not all three. If you are risk adverse and would like some extra money in a year or two, savings would likely be the option for you since it offers a stable return. If your time horizon is longer, investing may best serve your purposes and you should see returns that will likely triumph the returns you can achieve from a savings account. If you want high returns in a short period, trading may your best bet. However, it must be stressed again that trading is extremely risky.

Naturally, saving, investing, and trading are not mutually exclusive. In fact, we recommend employing multiple strategies simultaneously to take advantage of each strategy’s strengths. For instance, it may be beneficial to open a savings account for occasionally large spendings whilst also periodically paying into a larger investment account that may hopefully fund your retirement. If you are feeling adventurous and can tolerate the possibility of losing some cash, you may also want to consider a small trading account.

After you have allocated your £100,000 into the relevant savings, investing and trading accounts, do not neglect the importance of periodically revaluating and restructuring your portfolio. Economic circumstances will inevitably change as will your individual circumstances. For instance, if interest rates are low, as they are now, consider allocating more to your investments. With enough dedication and discipline, you may be much closer to achieving financial freedom than you realise.