What is 'Saving'?

'Saving' happens when your income exceeds your expenditure. So it's a consequence of three sets of decisions:

• your lifestyle choices, which set your spending levels,

• your work habits and career choices, which set your earned income, and

• your past saving and investment decisions, which set your investment income.

The consequence of saving is 'savings'. We reserve the term 'investment' for the process of deciding what to do with your savings. 

(Warning. The savings industry uses the term ‘savings’ differently, to describe the act of putting your money into bank and deposit accounts. The term 'investment' is reserved for putting your money into places where either the return of capital (getting your money back) or the amount of periodic payments (receiving interest or dividends) is uncertain. This distinction is convenient for the industry in classifying the products and services it offers. But it's not convenient for you, who should be thinking about both activities in exactly the same way - as you will see.

Where do you keep your money?

You put your money with any reliable institution that takes it and promises to give it back. Usually called a bank.

Where do you keep your other savings?

You save by buying something with the expectation (and hope!) that it will help you meet your money needs in the future. The things that you buy are called ‘assets’. Buying an asset is the same as investing.

What are assets?

Your cash in a bank is an asset:-

• so is ownership of your home;

• so is ownership of bits of other peoples’ enterprises (i.e ‘shares’ of ‘companies’);

• so are loans to other organisations under agreed terms for payment of interest and repayment of loan (‘bonds’). When the loan is to the UK government these are called ‘gilt-edged bonds’ or ‘gilts’;

• so are anything that has some sort of inherent value that people will pay for in the future - gold, other base materials (‘commodities’), land, buildings (‘properties’), art, bitcoin……..

So assets are those things which you hope will provide compensation for you in the future for what you paid for them in the past. Assets are a store of value.

There are lots of different sorts of assets. To simplify, they are sometimes grouped into classes. The most common classes are cash, companies, property (houses), bonds and commodities (including gold).

Easy assets

The only assets you will be involved with in the ‘Easy’ and ‘Simple’ modules will be cash, company shares (or organised collections of company shares called ‘Funds’) and your home.

However this simple structure must be embedded in a complicated world that we need to help you navigate. If you decide to invest in shares, for example, there are a number of different ways of doing it and you have to decide which way to use..

Products

The financial services industry provides an essential service in bundling up lots of different assets into a single package to save you having to do it for yourself. These bundles make up another type of asset. They are called ‘products’.

There are a vast number of different products available. In choosing to invest in one you must consider :-

• what are the underlying assets, and

• what are the extra costs of providing that product - i.e. the service costs? Is it worth it?

Concepts of value

When you choose to save you need to find assets with value for you.

Four concepts dominate any consideration of the ‘right’ savings for you: ‘return’, ‘risk’, ‘flexibility’ and ‘costs’.

• ‘Return’ is a measure of what you get back from your investments in excess of what you put in. Put another way, it’s a measure of how fast an asset increases in value, or distributes value, or both. In the simple case of a cash deposit your ‘return’ is the interest on the deposit. For other assets it is more complicated (see Simple Money later).

• ‘Risk’ covers all those things that make ‘return’ uncertain. You will find later that we prefer to use the word ‘Uncertainty’.

• ‘Flexibility’ is the capacity for you to alter the terms of your savings contract according to what suits you. Your future life events are uncertain. So your future money needs are uncertain. This makes ability to change your mind valuable. We discuss this more generally in Hanging Loose.

• ‘Costs’ are what you pay to others. They include service costs and, importantly, they include tax. Costs reduce your returns,

The balance of risk and return that’s right for you is fundamental to any savings plan. We will have much more to say on this later.

How you cope

You must simplify!

We recommend the following:

• Apart from your home, limit your assets to cash and shares.

• Don’t buy individual shares, but…

• Buy a ‘fund’ (or a number of separate funds). ‘Funds’ are groups of assets bundled together to help you spread your risk through the vital activity of Diversification.

• Embed all this in your review process.

You are doing this to obtain the extra return from taking on risk in a manageable way. We do not explain this concept until the second lesson (‘Simple Money’). But we believe it is possible for you to manage your money adequately without fully understanding them.

There is one more complication you need to handle:

Pensions

At some time in your life you have to prepare financially for your retirement. To encourage this the government offers major tax breaks for locking your savings away until you are older. And the largest advantages accrue when you start young, as you will see.

The catch is that pension decisions are irreversible until near retirement - they are very inflexible. So your savings plans must cover not just the balance between risk and return but also the split between pensions and non-pensions.

The word ‘Equities’

Buying individual shares, or investing in a fund that buys shares for you, or investing in a pension that does the same, are all different ways of making much the same investment but with different legal and cost structures around them. We need an umbrella word to cover all these things. That word is ‘Equities’. We talk about ‘investing in equities’. When discussing uncertainty we may say ‘taking equity risk’.

The American word for ‘share’ is ‘stock’. In England (and on this website), both words are used.