In finance, investing, saving, and spending is “the good, the bad and the ugly” representations that I use to describe the three options in dealing with money.
Most people see investing, saving and spending as three different options. All three options have their pros and cons. However, they should be considered three various tools depending on the job that requires attention. Some jobs require using more than one tool at a time.
The more money you have at your disposal, the more opportunities you’ll have.
Spending and Saving
Spending is a sin for those who save money and a pleasure for others who live like there’s tomorrow (YOLO). The ideal way is to balance both.
Saving money is a good thing, especially when considering investing in a property, going on a holiday, buying a car, or any long-term project. However, one can lose money by saving too much.
Inflation is the increase in the general rise in prices of goods and services. If a loaf of bread used to cost €1 and now costs €1.20, the price would have increased by 20%. If one had €100 – one could previously buy 100 loaves of bread, now they can only buy 83.
The €100 now buys fewer loaves meaning that the purchasing power of money has declined. You will need €120 to buy the same amount.
The purchasing power of money has declined; you will need more money to buy the same amount of goods.
The average inflation for 2021 was 5% in the Euro Area, 5%, 5.4% in the UK and 7% in the US. If you had €100,000 in your bank account at the start of the year, the same €100,000 can only buy €95,000 worth of goods.
The inflation rate works the same as a loan. The amount is compounds from year to year. Say if the inflation for Year 0 was 0, year 1 was 2%, year 2 was 5%, and year 3 was 3%. The increase in inflation between year 0 and year 3 is 10.3%.
Higher replacement costs
The more money someone saves, the less one spends and vice-versa. Some may people opt to buy cheaper goods. For example, someone who requires safety shoes for their line of work may fall into the trap of buying cheap ones. Cheap safety shoes may cost €50 and last a year. Their replacement will cost €50 each year. However, a good pair may cost €250 and last more than five years.
Certain quality goods may be much more expensive than cheaper ones; however, they would last longer and offer better after-sales service or availability of spare parts after the product’s shelf life.
On the flip side, a higher price doesn’t necessarily justify a quality good or service. One must be cautious as certain goods and services have higher branding and marketing fees that don’t justify the excess price.
Spending must be sustainable – you should never spend more money than you have. Spending too much money may lead to debt. There can be periods where one has to spend more money than one earns. Ideally, reserves should back such spending.
Most people consider saving and spending as two sides of the same coin. However, there exists the third side – investing.
The purpose of investing is to increase your monetary holdings. Investments refer to assets. For this article, assets are those items, either physical or virtual, that increase the value of your financial holdings.
For example, a house is an asset, as the price of real estate tends to appreciate over a long time. Shares, cryptocurrencies and a patent are assets too.
Vehicles aren’t assets in terms of investing, as they tend to lose their value.
How much money should you invest?
I reply by asking another question, “how much money can you afford without affecting your life should you encounter financial problems?”
Remember the disclaimer that follows every financial ad “the value of an investment may go down and up, and you may not get back the money you invested.” It’s essential to keep it in mind whenever you consider investing.
Your investment money can be less than a hundred Euros, and it may be thousands for others. Before investing, prioritise having enough money for food, fuel, and settling bills. Never invest money you can’t afford to lose, as investing requires an element of risk.
Money in a fixed-rate bank account is not an investment but a way to make your bank rich with your money. How? In simple terms, the bank will use your money to issue new loans against your deposit. An amount of €1,000 can generate €5,000 worth of loans. The system applied by the bank is known as fractional reserve banking.
Investing is not a get quick rich scheme – it’s something long term.
Reasons to invest over saving
I would opt to invest my money rather than save it in the bank for the following:
- Leaving too much money in a bank will make the bank richer. The bank will give you close to 0% on your money, while it can borrow it to those seeking loans and earn fees on interest rates and other loan-related fees like paperwork, life insurance, etc.
- Your primary objective of investing is to beat inflation. Inflation kills purchasing power. If the current year’s inflation is 5%, your goal should be to at least have a return on investment (ROI) of 5%. Your ROI should cancel the inflation. The higher the ROI, the better.
- Let’s say you would like to buy a house; however, you can’t afford it for the time being. For example, if the prices of property increase by, say, 3% every year and an ROI of your investment generates 10% every year, you’re earning 7% more than the increase in the property’s price. The advantage is that you may need to borrow less money in the future, and the cost of borrowing will be lower.
Where should you invest your money?
There are plenty of legitimate opportunities where to invest your money. These include shares (ownership in a company), bonds (loans to a company), property, art, cryptocurrencies like Bitcoin and Ethereum, etc.
Every investment has its own risk and reward. The generally maxim is that the higher the risk, the higher the reward and the lower the risk, the lower the reward.
However, the same applies to the opposite direction. The higher the risk, the higher the loss and the lower the risk, the lower the loss.
I will be discussing the pros and cons of different investments in future articles.
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