What Is Investing?

If you have a pension, Stocks and Shares ISA or investment account, there is a good chance that some of the money you have set aside for the future is already invested.

Yet investing can sound more complicated than it really is.

It can bring to mind stock market screens, people buying and selling shares or trying to predict what markets will do next.

At its simplest, investing means using your money to buy assets with the aim of receiving an income or increasing their value over time.

Unlike money held in a typical savings account, the value of investments can rise and fall. Returns are not guaranteed and you could get back less than you invested.

So why would anyone accept that uncertainty?

To understand that, it helps to start with the difference between saving and investing. 

Saving and Investing Are Different 

Imagine you have £10,000.

You could put that money into a cash savings account.

The £10,000 doesn't rise and fall because the stock market has had a good or bad day. You may also receive interest on top.

If you invest the £10,000, something different happens.

You use the money to buy assets whose values can change.

At some point your investments might be worth £10,500. At another they might be worth £9,500. Over time, you hope they will increase in value or provide an income, but neither is guaranteed.

Saving gives you greater certainty about how much money you have available. With investing, you accept more uncertainty in return for the opportunity to achieve higher returns than you might receive from cash over time.

That doesn't mean saving is safe and investing is risky.

They involve different risks.

Money held in cash doesn't usually fluctuate in value with investment markets, but inflation still matters.

If the interest you receive doesn't keep pace with inflation, your money will gradually buy less.

Suppose something costs £10,000 today. If its price rises over the next ten years, you will need more than £10,000 to buy the same thing in future.

The amount shown on your bank statement hasn't fallen.

What it can buy has changed.

Investing introduces a different uncertainty. Your money has the opportunity to grow more over time, but its value will fluctuate and there is no guarantee that you will make a profit.

Saving and investing can therefore solve different problems.

Why Would Anyone Invest?

If investing means accepting the possibility that your money could fall in value, why do it?

The reason is the opportunity for a higher return over time.

Investment returns can broadly come in two ways.

The first is income.

A company might pay some of its profits to shareholders as dividends. A bond might pay interest. A property might produce rental income.

The second is growth.

An asset you bought for £1,000 might later be worth £1,200.

Of course, it could also be worth £800.

Neither income nor growth is guaranteed and different investments involve different risks.

Investing gives you the opportunity to achieve higher returns than you might receive from cash, but accepting investment risk doesn't guarantee that you will. You can read more about this in What Is Investment Risk?

What Are You Actually Investing In?

When you invest, your money doesn't simply disappear into "the stock market".

You are buying assets.

If you buy a share, you own a small part of a company.

If you buy a bond, you are lending money to a government or business. In return, it usually agrees to pay interest and repay the money at a specified time.

Property is another type of asset that can be owned as an investment.

Many people don't buy these investments individually. Instead, their money may be held through investment funds that bring together money from lots of investors and use it to buy a collection of investments such as shares and bonds.

A pension or Stocks and Shares ISA can then hold those investment funds.

The important point is that investing means your money is being used to own assets or lend money to governments or businesses.

I explore some of these separately in What Is a Share?, What Is a Government Bond?, What Is a Corporate Bond? and What Is an Investment Fund?

Investing Isn't the Same as Trading

Investing and trading both involve buying and selling assets, but they aren't necessarily the same thing.

Trading is often concerned with trying to profit from shorter-term changes in prices.

Someone might buy a share because they believe its price will rise over the next few days or weeks, intending to sell if it does.

Investing is usually concerned with owning assets for longer periods, with the aim of receiving an income, benefiting if they grow in value or helping to fund something in the future.

That doesn't mean an investor never sells anything.

Investments can be reviewed and changed. Circumstances change too. An investment that was appropriate in the past won't necessarily remain appropriate forever.

The distinction is more about what you are trying to achieve.

For an investor, buying and selling isn't usually the objective. The investment is there to do a job.

The Job of the Money Matters

Imagine you have three different pots of money.

1. The first contains money you keep available for emergencies.
2. The second is money you plan to use towards a house deposit in two years.
3. The third is money in a pension that you don't expect to need for another 25 years.

All three pots contain money, but they don't have the same job.

The emergency money needs to be accessible when something unexpected happens. Keeping money available for emergencies can also reduce the risk of having to sell investments at a time when their value has fallen.

The house deposit has a specific job and a relatively short timeframe.

If you invested it and markets fell significantly just before you wanted to buy the house, you might no longer have enough for the deposit. Knowing the money will be available when you need it may therefore matter more than the opportunity for additional growth.

The pension is different.

If you don't expect to need that money for 25 years, a fall in investment values next month doesn't have the same immediate consequence.

There is more time to live through periods when investment values fall without needing to sell simply because you need the money immediately.

A longer timeframe doesn't guarantee a profit or remove the possibility of losing money.

It does, however, change the decision.

Holding money in cash for several decades brings a different risk. Inflation could gradually reduce what it will buy and the money would have less opportunity for investment growth.

This is why asking whether saving or investing is "better" isn't particularly helpful.

Better for what?

What Is the Money For?

Before deciding whether money should be saved or invested, there is a more useful question to ask.

What is the money for?

Money you might need next month has a different job from money intended to support you in retirement decades from now.

So when might you need it? How important is it that a particular amount is available at that time? What would happen if its value fell? How much flexibility do you have if things don't go as expected? Does the money need the opportunity to grow over many years?

The answers can help determine whether saving, investing or perhaps a combination of the two makes sense.

Together with your wider circumstances and attitude to risk, they can also help determine how much investment risk it might be reasonable to take. I explain what this means in more detail in What Is Attitude to Risk?

This is why investing shouldn't begin with trying to work out which market, fund or company will perform best.

It should begin with understanding the job the money needs to do.

Investing Is a Means, Not the Destination

Investing isn't simply about trying to make your money grow.

You are accepting that its value can rise and fall along the way because of what you hope the money will help you achieve in the future.

That might mean funding retirement, becoming more financially independent, helping your family, buying something many years from now or simply giving your future self more choices.

The investment is the means.

What matters is what you eventually want the money to make possible.

Which is why the question that comes before "Should I invest?" is usually much simpler.

What is the money for?

This article is for general information only and should not be treated as personal financial advice. Whether investing is appropriate, and the investments that may be suitable, will depend on your individual circumstances, objectives and ability and willingness to accept investment risk.

Matthew Birkett
Chartered Financial Planner
Birkett Financial Planning