Generally, cash savings are appropriate for goals that are less than five years away – maybe you’re saving for a house deposit or are planning to get married, for example. Crucially, cash can provide peace of mind that your money won't suddenly fall in value just when you need it, which is important if you don’t have much time to wait for it to recover.
It’s also worth having some cash savings for a rainy day – when life presents an unexpected expense or your circumstances change and you need to access money quickly. The amount you’ll need will depend on you and your circumstances – consider factors such as what your monthly outgoings are; whether you’re the sole earner in the household; how long you think it would take to find a new job if you were to lose yours. For one person, having three months’ salary will be enough but someone else might feel more comfortable with a year’s salary.
Many savings accounts allow you to take money out whenever you want, though some don’t permit withdrawals for a certain period of time. These tend to be the accounts that pay the highest rates of interest so this is worth bearing in mind when comparing savings rates.
Once you’ve built up your rainy day savings and have enough to cover those short-term goals, you might then want to consider investing because while low risk, cash is by no means risk-free. You won’t lose money in cash but it often struggles to keep up with inflation – rising prices – so your spending power can fall over time.
However, before you commit your money to the stock markets, there are a few other things to consider. While you don’t necessarily have to be debt-free, you’re probably not ready to invest if you've got money outstanding on credit cards and loans or are regularly overdrawn so look to pay those down first.
Also, don’t overlook protection insurance: life insurance, critical illness cover, and income protection are all important things to consider because your savings and investments would only go so far if your income was suddenly to stop. If you’re not sure which protection option is right for you, seek independence advice.
If you’re planning your finances for the longer term – five years or more – investing offers the chance to get your money working harder because you should get better returns than you could from cash.
There will be periods when the stock markets fall, but there will also be periods when they’ll rise and the longer you keep your money invested, the more time it has to grow which reduces the risk of your investment falling in value.
It’s therefore worth considering for financial goals that are some way off, such as retirement and children’s education costs. And even if you don’t have a specific goal, investing can help in terms of building your wealth to provide you with greater financial security.
As well as time being a key factor, diversification is also important when it comes to investing.
When starting out, it’s common for people to buy shares in a single company. However, this is quite a high risk strategy because your fortunes are dependent on the performance of that one company. It’s therefore important to diversify and spread your money between different companies, sectors, geographical regions, and also different asset classes. That way, even if one company doesn’t perform very well, others will be doing okay. While not eradicating the risk completely, diversification can reduce the chances of you losing money.
You can do this yourself by buying different shares and bonds, but a simpler way is to invest in a fund, where your money is pooled with that of other investors and invested in multiple companies.