In today’s tight economic climate, many people wonder what is the best method of improving their financial position. We read that we should make our money work for us but worry about making a wrong decision that could actually cost money rather than make us money. In this article we will look at the pros and cons of saving and investing, as well as reducing debt, as a means of gaining financial security.
If you are pondering this question, you probably have access to some spare cash; otherwise you wouldn’t be considering either savings or investment. So, your question could well be – “What should I do with my spare cash to get the best return?” When I found myself in this position a few years ago, this was the question I asked myself.
What Is Saving?
Saving means that you deposit a sum of money, which you can generally add to over time, into an account with a bank, credit union, savings and loan or other financial institution. The bank uses your money for lending and pays you a pre-determined interest rate for that privilege. You can be confident that your original cash deposit amount will be available to you whenever you need it, along with any interest that has accrued. Even if a bank goes bust, the least you can lose is the interest; your own money will be safe. The down-side of this method is that interest rates are usually quite low so the amount your money makes for you is small.
What Is Investing?
Investment in the stock market seems to be attractive at the moment because stock prices are still low, which means that investors can buy more shares for their money. For investors who are looking at the long-term, this could be a viable option, as the stock prices will invariably rise over time. If you want to get your cash back, you need to sell your shares; the price of your company’s stock may have gone up and so you will make a profit. Conversely, the price may have dropped and you can only sell them for less than you paid for them. In effect, you will lose money because you won’t get back the amount you originally invested. This potential for loss is the major difference between savings and investment. The rewards are potentially higher with investments but so is the risk of losing your money.
If you decide to invest in real estate, precious metals or collectable items, the same situation applies as investment in the stock market. The potential for good returns exists but so does the possibility that you will lose money.
What About Debt?
The chance viewing of an interview on TV gave me a third option – that of using my cash to pay off my debts, especially high-interest debt. It sounded like a strange suggestion as a means of improving one’s financial position but I soon came to realize what good advice it was. By throwing my spare cash at my high interest credit card debt, I would be saving money by reducing the amount of interest I would have to pay. A dollar saved, as they say, is a dollar earned.
What Should You Do?
To check whether this is the best option for you, you need to know what after tax interest rate your debt is costing you. Then you compare that with the rate you would expect to get from investing or saving your money. If you can earn more interest from your investment, then this is the way to go but if you will save more in interest by paying off your debt faster with your spare cash, you should do that. This tactic will generally work best with high interest debts like credit cards rather than lower interest loans like mortgages.
If you have several credit card balances, accruing high interest, start with the most expensive one and get it paid off first. If they all have similar interest rates, start with the smallest balance and pay it off. Then you can throw the money you used to pay that one off at the next smallest balance, until it is also paid off. This strategy is called the snowball effect and allows you to pay off each balance and then put extra money into paying off the next one.
You might really want to start some investments but you owe it to yourself to do what is best for your financial future. Cash is king in today’s climate and every dollar you save in interest on personal debt is effectively a dollar you have paid to yourself. Your long-term financial plan should include being debt-free (because it is a constant drain on your finances) in conjunction with a lucrative investment portfolio, which is steadily increasing your wealth.
What do you do? Save or invest?