Money magic: Investment is a risky business

With interest rates paying little on savings, there is a temptation to invest. But beware, says Paul Lewis

Do you have savings? Put it another way, do you have investments? Question three: do you know the difference?

As the interest earned on savings follows the official bank rate towards zero, there is a temptation – fuelled by some financial advisers – to take the cash out of savings and put it at risk.

The difference between savings and investments is risk. When you put money into a savings account it stays yours. Then the bank or building society uses it to lend out to other people, that is how it earns interest. But when you want your £1,000 (or whatever) back you can get it. It is yours and the Financial Services Compensation Scheme guarantees up to £50,000 of it even if the bank goes bust.

But if you invest the money then it is no longer yours. Instead you have a piece of paper – a share, a unit trust, an IOU (such as a corporate bond) or a bar of gold – and even that can be a piece of paper rather than an ounce of the yellow metal. Then when you want your money back you have to find someone who will buy that paper off you. The amount of cash you receive back, after commission, is what your investment is “worth”.

Of course, you may sell the piece of paper for more than you paid but you may have to settle for far less. It is called risk, which, despite what financial sales people tell you, does not mean reward: it means risk. You may get more (reward), but you might also get less. Afterall, if risk really did always mean reward then there would be no risk.

One person for whom risk always does mean reward is the person selling you stuff. They will get commission whether your investment grows or shrinks. In other words although you take the risk, they receive the reward.

In the first few months of 2009 more than £2bn has been taken out of cash savings in this country. Some has been spent. But the rest is now invested rather than saved at risk rather than safe. So if a salesperson tries to persuade you to take your money out of savings and invest it, ask them what “risk” means. If their answer does not include the phrase “it means you can lose some or all of your money” politely say “no”.

Paul Lewis is a freelance writer who presents Money Box on BBC Radio Four

This article appeared in the 12 March edition of Community Care