Is it better to save or invest?

One of the most common questions we get from clients is whether it’s better to invest their money or simply save it.

In this context, we’ll use the term ‘investing’ to refer to owning listed securities such as shares, bonds, and investment funds like ETFs or mutual funds. We’ll use ‘saving’ to refer to lower-risk, interest-generating accounts, such as cash ISAs or savings accounts with banks and building societies.

Both saving and investing are essential parts of a strong financial plan, but the right choice depends on your individual goals, risk tolerance, and time frame. For many, the prevailing interest rates available will also make an impact on your strategy; if interest rates are high, there is more incentive to save, and vice versa.

In most cases, a balanced approach that combines both saving and investing is ideal. After all, we often have multiple financial objectives with different timelines, such as needing funds for a short-term expense like a home deposit, while also planning for long-term goals like retirement.

While this article is not intended as a personal recommendation, it is designed to help individuals consider how best to allocate surplus income between cash savings and long-term investments.

The case for saving

Saving money provides a financial cushion for emergencies and short-term goals. It’s a low-risk way to preserve capital, with products like savings accounts and Cash ISAs offering flexibility and the reassurance that your money won’t decrease in nominal terms.

While returns are typically lower than investments, savings are ideal for near-term needs (think emergency funds or a significant expense), especially given today’s relatively high interest rates.

That said, cash savings aren’t entirely free of risk. A major risk is inflation. Inflation can erode your purchasing power if it outpaces your returns, a more pressing issue in recent years, particularly after 2022, when the world experienced a significant surge in inflation, often referred to as a “Great Inflation” period.

The chart below compares the UK Consumer Price Index (CPI) – shown in blue – with the Sterling Overnight Index Average (Sonia), shown in red. CPI is the UK’s main measure of inflation, while Sonia reflects short-term interest rates based on the cost of overnight lending between banks. Both show rolling returns, capturing the compounding effect of time over the past seven years (since 01/06/2018). We’ve chosen this period as a representation of a long-term investment horizon – typically seven years or more – where investors can reasonably tolerate market volatility.

While Sonia is a short-term interest rate between banks, plotting its rolling returns over time shows what could happen if someone consistently earned Sonia-level interest and reinvested it. Sonia doesn’t directly reflect the interest rates available to retail savers, as it measures the average rate at which banks lend to one another—not to individuals. Because banks typically borrow at lower rates than they offer to customers, savers may have earned slightly more than Sonia on average. Still, Sonia plays an important role in shaping retail rates, including those on savings accounts and mortgages, which makes it a useful benchmark for understanding overall interest rate trends over time.

What’s visibly clear here, is that interest rates (and therefore savings rates) have not matched inflation over the last seven years. What’s particularly pertinent is that CPI has increased by some 31% over the last seven years, where the compound returns from Sonia have increased by some 15%. In other words, the average price for goods, services and housing costs has gone up by around 31% since June 2018. Had you been saving your money in a savings account which paid interest in line with Sonia, you’d have returned about 15%. Indeed the returns you’d have generated between 2018-2022 were very marginal since interest rates were so low. 

In short, the cost of living has gone up by twice as much as you’d have been paid in interest on your savings. Unless your savings and investments have returned more than 31% over the last seven years, they have fallen in real-terms value. Despite being worth around 15% more in nominal terms, they now buy less than they did seven years ago due to the impact of inflation.

Investing growing your wealth over time

Investing, on the other hand, is aimed at long-term wealth growth and typically offers higher returns than savings, but with greater risk. It suits goals like retirement or other long-term objectives by owning assets such as stocks, bonds, real estate, or investment funds which can cover a few different assets.

The main perceived risk is volatility, which is the ups and downs in asset values. It isn’t inherently good or bad but signals the degree of price fluctuation. Some assets are more volatile than others, and an investor’s ability to tolerate that volatility often depends on how long they plan to stay invested. For example, someone saving for retirement in 30 years can usually endure more market swings than someone needing funds in two years.

Over time, market volatility tends to smooth out, and the likelihood of losses decreases. While markets move in cycles, the long-term trend of global markets is generally upward. A well-diversified portfolio becomes less likely to produce negative returns the longer it’s held, and for that same reason an investor with a long time horizon can afford more volatility, therefore making volatility more manageable.

The chart below is a continuation of the chart above, albeit with two new lines added. This time it includes the past performance of two Moneyfarm portfolios; our risk level 5 (the orange line), a traditional 60% stocks and 40% bonds portfolio, and the new risk level 7 portfolio (the purple line), our highest risk, which invests solely into global equities.

Our risk level 7 is innately more volatile than its more balanced counterpart, as illustrated in the chart. It’s also seen higher levels of returns. This can mainly be attributed to its allocation equities have generally outperformed bonds over time, though past performance doesn’t guarantee future results.

In both instances, these portfolios have outperformed the cumulative returns made in interest (as defined by Sonia) and inflation. Our risk level 5 has, since 2022, kept up with the pace. Despite sharp bond losses in 2022, driven by rising inflation and interest rates – which share an inverse relationship with bonds – exposure to riskier assets like stocks helped performance. While history isn’t a perfect guide, this highlights the value of diversification.

The key here is that periods of abnormally high inflation like we saw in 2021-22 can rapidly eat away at your real-returns which you might have been accruing over several years. If you’re aiming to beat inflation over the long run, you need as much growth as possible.

Savings rates are high, so why would I take the risk?

In financial markets, we often refer to market sentiment as being bullish (optimistic) or bearish (pessimistic). Let’s define a market which has risen by 20% from its last trough as a bull market, or a market which has fallen by 20% from its last peak as a bear market. Historically, on average, bull markets last for six years and 10 months, where bear markets last for one year and three months, according to research from Vanguard Asset Management 2024.

This is to say that in general, markets spend more time going up than they do going down. Therefore if you spend long enough in the market, you’re unlikely to see a nominal loss on your investment. Here’s an example to illustrate this point.

The chart below plots four major index funds. The S&P 500 (US shares), the FTSE All World (Global shares), the Euro Stoxx 600 (European shares) and the FTSE 100 (UK Shares). Each has performed differently, yet demonstrate shared trends in their overall performance; they slump and rally at similar points, and overall demonstrate an upward trajectory on average.

Savers vs investors who wins?

To simulate historical returns in a Cash ISA, we will again use the Sonia in red – a key measure of interest rates as defined by the inter-bank borrowing rate. To simulate historical returns in a Stocks and Shares ISA, we’ll use the FTSE All-World composited index in blue – a market index tracking some 4,000 global stocks.

Both of these indexes show absolute rolling returns; they account for regular contributions plus the compounding effects of time periods over the last 25+ years (since 06/04/1999). In this scenario, you have contributed £100 a month to both of these pots, on the 6th of each month. Therefore, you have made total contributions of £31,500 towards both pots since inception.

In the above scenario total returns in your Cash ISA would be equal to £36,164.60, whereas the equivalent contributions towards a FTSE World index-tracking fund might’ve grown to a value of £138,829.37 in the same time-frame. 

It’s also worth viewing this chart in the context of inflation. Let’s plot the two same indexes against each other again, and this time include a third index the Consumer Price Index (CPI), the preferred indicator of inflation and denoted in green. Given the CPI is not an investible index, let’s not account for any contributions, and instead look at absolute returns in percentage terms.

This image is especially powerful. Over the past 25 years, the FTSE World Index has grown by 618.74%, while Sonia rose 90.81% and inflation (CPI) by 92.21%. So, savings just kept pace with inflation, whereas global equities outperformed it by about 6.7 times.

Notably, around 2022, a brief period of high inflation sharply reduced real savings returns. This underscores the importance of factoring in inflation when planning long-term finances.

Striking a balance

Rather than choosing one over the other, the optimal strategy likely involves a combination of both saving and investments. As a general rule of thumb, it’s prudent to have between three-six months of regular expenses saved in a liquid, low risk savings account so that you have some financial windfall in the event of any financial setbacks like job loss, or an unexpected expense.

If you have meaningful liabilities or expenses planned for the shorter term (one-three years), it may also be sensible to keep these funds saved in lower risk products like savings accounts, to minimise the risk of financial loss.

Remember, your financial situation is unique, and there’s no one-size-fits-all answer. Assess your goals, risk tolerance, and time horizon to determine the best balance for you. 

Beyond that, it’s clear that if part of your financial goal is to save for the long term – and indeed to focus on capital growth and/or beat inflation – you’ll want to consider investments too. As we’ve observed above, savings are not without risk. The risk of failing to outpace inflation is very real – especially during periods of elevated inflation. This is precisely why your workplace pension schemes are invested for you, and do not just sit generating interest; over the very long term – potentially decades – investing in global markets is one of the best ways for individuals to grow their wealth, and therefore reduces the risk of your wealth being eaten away by inflation over time.

At Moneyfarm, we now have products to help you meet your various goals. For those with greater risk appetite or long-term financial goals, we manage a whole variety of diversified portfolios, at different risk levels. Our proprietary suitability algorithm is there to ensure if you do wish to invest, you’ll receive a suitable recommendation in-line with your investor profile.

You can also hold a variety of portfolios and products with us, to help meet your various goals. Best of all, most of these products are eligible to be held in a variety of wrappers, whether that’s an ISA, a Junior ISA, a self-invested personal pension (SIPP), or a general investment account, or a combination thereof.

As always, if you wish to discuss any one of our products or services, please reach out to our investment consultant team.

This article is for information only and does not constitute a personal recommendation or investment advice. Past performance is not a reliable guide to future returns. All investing involves risk, and you may get back less than you invest. Any returns shown are based on historical data and are not guaranteed. Before making investment decisions, consider your individual objectives, financial circumstances, and risk tolerance. If you are unsure whether investing is right for you, please speak with a regulated financial adviser.