To save or to invest

QUESTION: I have $1 milion in my savings account and would love some advice on the best way to invest — maybe towards a home. I also have $400,000 in a fixed deposit.

- Dawson

PFA: Saving and investing are often used interchangeably, but they are quite different. It seems you want to make a significant shift in how you manage your money. Whether you opt to save or invest depends on your goals, risk tolerance, and time horizon.

To save is to store money safely.

Savings are initially derived by consuming less than is earned. This surplus income is often placed in low- risk financial instruments such as savings accounts, money market accounts, and certificates of deposit.

Although many people place their funds in these for extended periods, a savings programme should really be for short-term needs such as for programmed expenses and emergencies, and for income.

Savers tend to have easy access to their funds. Savings instruments, being low risk, give low rates of returns, generally below the rate of inflation.

To invest, on the other hand, is to grow money.

Investment instruments

Investing is long term but risky because investment vehicles tend to experience changes in their value. These changes may be positive or negative. Examples of investment instruments are stock, real estate, bonds, mutual funds, unit trusts, and businesses.

All investment instruments do not carry the same level of risk, but they tend, to varying degrees, to create challenges to investors who may desire to convert them to cash at short notice.

Apart from capital appreciation, returns may be derived from interest, dividend, and rent.

Investing cannot take place if there are no savings. Individuals who want to invest but have no savings of their own must borrow the savings of others to do so. Ultimately, investing is the key to the building of wealth as it generally leads to real rates of return — greater than the rate of inflation — in the long run.

From the limited information you have provided, it appears that you are quite conservative because all your funds are in savings instruments. Of course, this could be due to your limited knowledge of investment/financial matters.

Your approach to such matters may change as you become more knowledgeable.

You do not seem to be clear about what particular goal you want to achieve, though there is a strong hint that home ownership may be your top priority. If that is the case, it is best to start planning now, giving consideration to such matters as when you would want to make the purchase, the price and location of your desired house, how much you can afford to save, and how you will source the difference between the cost of the house and what you will be able to contribute to the purchase.

Apart from the deposit, which could be as much as 15 per cent of the value of the property, assuming you plan to buy on the open market in preference to building, there are other fees such as stamp duty which can be as much as six per cent of the value of the loan if you need to borrow.

Bear in mind also that you may be required to earn a gross salary that is about three times your monthly mortgage payment.

Consider from now where you can source the best rates and terms for your mortgage. Credit unions lend a fixed dollar amount. Building societies lend a percentage of the market value, as does the National Housing Trust, which lends at lower rates than other lenders. Currently, it lends $3.5 million to a single borrower, and $7 million if there is a co-applicant.

Considering the rate at which the price of real estate is increasing, the sooner you are able to buy, the better. If you can make a purchase in the short term, you need not concern yourself with investing; your focus should be preserving your principal.

Focus on instruments like government papers that yield higher than savings accounts and certificates of deposit, but recognise that these do not allow you scope for earning tax-free income.

You may be tempted to invest in stock and unit trusts, for instance, if your objective is long term, but this is fraught with risk from what I said about investing above. I suggest you read what you can about investing and investment instruments so you can make informed decisions with the help of a competent investment adviser.

Oran A. Hall, a member of the Caribbean Financial Planning Association and principal author of 'The Handbook of Personal Financial Planning', offers free counsel and advice on personal financial planning.Email: finviser.jm@gmail.com