As kids, we were told to save — save in our bank account, or in our piggy bank. What we didn’t realise then is that if we had invested our money instead, we would have been further on the path to unlocking our financial freedom. Most people view saving and investing in the same light due to the similarities between them. One of the most notable similarities is that both involve saving towards a future goal. However, the key difference between the two lies in the asset class that you invest in. Investing involves putting money into more risk tolerant assets with the potential for higher returns, while saving is limited to cash-only assets (more risk averse) with lower returns. "
Pictured : Gabriel Botha, Retail Business Development at Prescient Investment Management
What is the difference between saving and investing?
When considering risk and returns and where assets classes fall on the spectrum, it would be as follows. The most conservative asset class would be cash, you would also receive the least amount on growth on cash investments. Moving up the risk curve would be other short term fixed income assets, then bonds, property and equity generally seen as the riskiest asset class, but it has proven itself the be the best long-term outperformer of inflation and creator of wealth.
At the end of the day, it comes down to how hard your money is working for you. Your money needs to equal the inflation rate to ensure you're not getting poorer and outpace the inflation rate if you want to grow your wealth. We now look at practical examples of these asset classes with inflation set at 5.2%. Cash (STEFI) 12 months return to end of June 2024 is 8.22% providing a 3.02% return above inflation. SA Interest-bearing money markets 12 month return to end June 2024 is 8.7% providing a 3.5% return above inflation. When considering Global Equities 12 month return to end June 2024 is 12.87% providing a 7.67% return above inflation. Over the long run the outperformance of inflation is what drives our wealth.
In our current higher interest rate environment, we have the unique scenario where money in the bank almost keeps pace with inflation. Over the long run money in the bank struggles or does not keep pace with inflation as inflation is often higher that the returns you receive in a normal bank account, this means you are not creating wealth by keeping money in your bank account.
As you start taking on more risk and investing in riskier asset classes you will notice your return after inflation increases, effectively creating wealth.
Rule of 72 and rule of 114
The risk versus return trade-off can be evaluated using the rule of 72 and rule of 114.The rule of 72 calculates how long it will take for your money to double given a rate of return. Take 72 and divide it by the rate of return that you can expect. If you can invest at 10% then take 72/10=7.2 this means it will take 7.2 years to double your investment at a rate of 10% per year. The rule can also be used for inflation to see how long it would take for your money to halve in value because of inflation. The rule of 114 calculates how long it takes to triple the value of your money by using the same method used for the rule of 72.
On your journey to financial freedom, it’s important to ensure you’re outpacing inflation by looking at the different asset classes and the value that they offer in terms of their long-term outperformance. So, how hard is your money working for you?
Disclaimer:
- Prescient Investment Management (Pty) Ltd is an authorised Financial Services Provider (FSP 612).
- Please note there are risks involved in buying or selling a financial product, and past performance of a financial product is not necessarily a guide to future performance. The value of financial products can increase as well as decrease over time, depending on the value of the underlying securities and market conditions. There is no guarantee in respect of capital or returns in a portfolio. No action should be taken on the basis of this information without first seeking independent professional advice. Calculations provided are for illustrative purposes only.
- This document is for information purposes only and does not constitute or form part of any offer to issue or sell or any solicitation of any offer to subscribe for or purchase any particular investments. Opinions expressed in this document may be changed without notice at any time after publication. We therefore disclaim any liability for any loss, liability, damage (whether direct or consequential) or expense of any nature whatsoever which may be suffered as a result of or which may be attributable directly or indirectly to the use of or reliance upon the information. For more information visit www.prescient.co.za
