Saving and Investment

For reasons of prevention and to seize opportunities: Saving serves as a "safety net" for the future in the face of unforeseen circumstances, such as an illness, a home repair, or an unexpected expense. In addition, saving makes it possible to purchase an item in the future and to take advantage of opportunities that may arise.

To create capital for future use (investment): Saving and investing are interrelated, as saving can be converted into an investment, if money is placed on financial products (such as bonds, shares, mutual funds), which can yield profits.

An investment is the placement of the money that each person possesses on an activity or product in order to gain greater value or generate profit in the future. Unlike saving, which primarily aims at security and prevention, investing aims at increasing the value of the money individuals have at their disposal. Every investment yields a return and is associated with a risk. 

Return is the profit derived from an investment and is usually expressed as a percentage (%) of the initial amount invested. It can be a fixed income, such as interest from a deposit, or an increase in the value of the asset, such as the value of a stock purchased by the investor. 
Every investment is associated with a risk (uncertainty), that is, the likelihood that the return may be smaller than expected, the value of the financial product invested in may decrease or even that part of the initial capital may be lost. For this reason, investments are associated with the possibility of both profit and loss.

In general, the higher the potential return of an investment, the greater the risk. For instance, an investment in government bonds is considered relatively safe with low returns, whereas buying shares from a private company may yield higher profits but comes with greater uncertainty.

When a person saves or invests their money, they receive interest, which is a sum of money calculated based on the interest rate.

Compound interest is generated when the interest earned is added to the principal and thereafter produces new interest as well. With compound interest, money grows not only due to the initial capital but also to the accumulated interest. For example, depositing 1,000 euro in an account with an annual interest rate of 5% will yield 1,050 euro after the first year. In the second year, the interest will be calculated on 1,050 euro and not just on the initial 1,000 euro, resulting in further growth of the amount.

Compound interest exponentially increases savings in the long term (the longer the investment period, the greater the benefits of compounding).

Bank deposits are the most common type of saving. Money is kept safely and may earn a small interest (that is, additional money as a “reward” for depositing money with the bank). We distinguish three types of bank deposits: 
a) The current account which allows daily transactions using cheques or cards and is therefore mainly used by businesses and professionals.
b) The savings account which is used for saving and enables customers (usually households) to deposit and withdraw money at any time; it earns interest on the account balance.
c) The fixed-term deposit account which offers a higher interest rate as the money is blocked for a specific period of time, thus reducing liquidity. Withdrawing money prior to maturity may incur a cost, such as loss of part of the interest. 

Bank deposits are generally considered low-risk products, but they usually offer lower returns compared to other financial products. 

Another option is to place our money on investment financial products, with an aim to generate profits in the future. These products usually offer a higher potential return than deposits, but they also come with greater risk. The most important ones are the following:

• Bonds: They are securities through which the investor lends money to the issuer, either to the State (government bonds) or to businesses and banks (corporate bonds). In return, the issuer repays the principal at the bond’s maturity and regularly pays interest called a “coupon”. The yield of a bond mainly comes from the interest (coupon) received by the investor, while the risk of a bond is mainly related to the possibility that the issuer may not be able to pay the interest or return the principal.
• Treasury Bills: They are short-term securities issued by the State. Like bonds, they are a way for the State to borrow money, but their maturity is shorter than that of bonds (usually 3, 6 or 12 months) and they do not pay interest. Their yield is the difference between the price at which they are purchased (lower than the nominal value) and their nominal value. They are considered a low-risk investment product.
• Shares: They are securities issued by companies and represent a small piece of ownership of the company. The return on a share comes from the potential capital gain, if the price of the share increases and the share is sold at a price higher than the purchase price (e.g. on the stock exchange), and from dividends, which constitute the part of the profits that the company distributes to shareholders. Shares carry higher risk than bonds, as the value of the shares is directly linked to the performance of the company.
• Mutual funds: They are considered indirect collective investments, as they pool the savings of many individuals and invest the capital they collect in various financial products (stocks, bonds or combinations of these). Investors do not directly own the stocks/bonds but own shares of the mutual fund. Through the mutual fund, diversification, i.e. the allocation of money into different investments, is achieved indirectly.

There are also other types of investment such as real estate, gold, works of art etc., which entail different degrees of risk and return. 

Every type of investment comes with some level of risk, that is, the probability that the return will be lower than expected or even that part of the initial capital may be lost. The level of risk of an investment largely depends on the type of investment. For example, bank deposits are usually low-risk, bonds have a higher degree of risk, while stocks carry the highest risk, as they depend on the performance of the company. There are three main risks:

• Credit risk: The risk that the borrower may not fully repay the amount they have borrowed.
• Market risk: The risk that an investor’s assets may be sold at a price lower than the purchase price.
• Liquidity risk: The possibility that converting an investment into cash may not be easy or immediate without a loss of value.

Understanding risk is important for making proper investment decisions.

The risk of an individual’s investments can be reduced through diversification, namely, by allocating the amount the individual wishes to invest across alternative financial products with different characteristics. In other words, the investor does not put all the eggs (their money) in the same basket (financial product). The set of alternative investments is called a portfolio.

The portfolio’s return is the average of the returns of the individual products (stocks, bonds, etc.). Respectively, the portfolio’s risk is lower than the average risk of the individual products. Therefore, effective diversification protects investors against risk.

Every person, before making any investment decision, should be aware of certain core principles:

• Past returns do not guarantee future ones.
• Every investment entails risk, meaning there is a possibility that the return will be lower than expected or that there will be a capital loss.
• Investments promising high and immediate profits are accompanied by higher risk.
• Diversification of financial products reduces the overall risk to which the invested money is exposed.
• The time horizon of the investment is very important, as it usually takes time for an investment to yield returns.
• It is not recommended to invest all the money a person has. An amount should always be saved for emergencies.
• Staying constantly up to date is key for investors. It is recommended to avoid investing in products that one does not fully understand.