Words on wealth: Saving, investing, trading – know how they differ

July is Savings Month in South Africa, so I thought I would revisit some basic concepts associated with taking a chunk of money you have earned and putting it into a financial product or instrument with a particular goal in mind.

The terms we use, “saving” and “investing”, are often used interchangeably. But “investing” is also used interchangeably with another term, “trading”, further adding to the confusion for the layperson.

So let’s clear up the confusion:

• Saving: The act of putting away money – either a lump sum or, more practically, small amounts on a recurring basis – so as to accumulate an amount to be used in the future.

• Investing: Buying assets such as company shares, bonds, or property that you believe have the potential to grow in value and/or provide a regular income.

• Trading: Speculating on the short-term rise or fall in the prices of higher-risk financial instruments, including shares, share derivatives, and currencies, including crypto, requiring active buying and selling.

As an example of how the terms are used interchangeably, we talk about “retirement savings” when we really mean “retirement investments”. This is because saving is normally associated with short-term objectives, whereas investing (not to be confused, in turn, with trading or speculating) is a long-term endeavour.

Ideally, you should be guided in these endeavours by a trusted financial adviser. But whether you use an adviser or not, you need to clarify your financial objectives, which can be divided into short-term and long-term goals.

Short-term goals are things like buying a car, having a deposit to put down on a property, or going on an overseas holiday. Your time horizon should not be more than five years.

Long-term goals are things like having the money to put your child through university and, vitally, having enough money to live on when you are no longer able to work – your retirement nest egg. Your time horizon here should be at least five years, preferably a lot longer.

What is important, particularly over the longer term, is that your money earns enough in interest or returns to beat inflation. 

Short-term saving

For short-term saving, you need a product, for want of a better word, that, unless you're putting away a lump sum, allows you to contribute regularly, possibly monthly, via a debit order on your bank account. But it must also be relatively risk-free.

Amazingly, while promoting their lump-sum savings products, such as fixed deposits, our banks are not very good at offering recurring-saving products. On those that are offered, the interest rates are typically low. 

Money market unit trust funds generally offer better rates than bank savings, and they are far more flexible – you can contribute or withdraw money at your discretion. However, depending on the fund, the minimum investment amounts for recurring or lump-sum investments may be too high for you. And the rate is not constant – it fluctuates in line with market conditions.

An attractive alternative is the National Treasury's RSA Retail Savings Bond that allows for multiple deposits. You cannot withdraw in the first three years, but in return, you currently get a rate of more than 5% above the inflation rate. (This is also a floating rate.)

Long-term investing

If you are saving for retirement, you need to be in a product specifically designed for retirement savings, because you can claim your contributions as a tax deduction. You can either contribute extra to your employer-linked pension fund or take out a retail retirement annuity. 

If you are saving for some other goal, you will be investing after-tax money. Discretionary investments include unit trusts, exchange-traded funds (ETFs), a share portfolio, and physical property. While the short-term risks on these investments can be high owing to market volatility, over the long term, you are likely to get higher returns than in a short-term interest-bearing account.

Unit trusts and ETFs are extremely easy to invest in, although, as with the money-market funds mentioned above, there are minimums on lump sums and recurring contributions. The asset managers offering these funds often enable you to invest directly via their websites. There is an overwhelming choice in this area, but for beginner investors, a so-called "balanced" fund (correctly, an SA Multi Asset High Equity fund) is the best way to go. These funds have a large portion of their portfolios invested in shares (equities), but are also diversified into bonds and listed property, resulting in a more even return than that of a pure equity fund.

It's important to note that there are no guaranteed returns in unit trusts and that past performance does not predict future performance. 

Tax-free savings accounts lie somewhere between retirement and discretionary investments. They are designed for long-term saving to supplement your retirement nest egg, but can be used for other purposes. Both banks and asset managers offer them, and their underlying investments can range from bank deposits to unit trusts and ETFs. Currently, you are allowed to invest a maximum of R36,000 a year, with maximum lifetime contributions of R500,000. Within the investment, you are not taxed on interest, capital gains, or dividends, as with a retirement-fund investment. Discretionary investments are subject to these taxes.

* Hesse is the former editor of Personal Finance.

PERSONAL FINANCE