There is a fundamental rule in finance: Risk and return are correlated. Generally, the higher the potential return an investment offers, the higher the risk you have to accept. Conversely, low-risk activities usually yield low returns. Let’s break down risk and return in context of saving vs investing:
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Savings – Low Risk, Low Return: When you save in a bank or MMF, the risk of losing money is extremely low (banks rarely fail, and even if they do you have some insurance, plus you can usually withdraw anytime). However, the return is modest. Often, the interest barely beats inflation.
For example, if your savings account gives 4% and inflation is, say, 5centralbank.go.ke】, your real return is -1%. This is why large balances sitting in a basic savings account for too long could be a lost opportunity.
The trade-off for having essentially zero volatility and full security is that your money’s growth is slow. It’s a deliberate trade-off that’s acceptable for short-term funds or emergency funds – you prioritize capital preservation over growth for that portion of money. -
Investing – Varied Risk, Higher Potential Return: Within investing, there’s a spectrum of risk and return:
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Low-Risk Investments: e.g., Government bonds, blue-chip stocks with consistent dividends, diversified balanced funds. These tend to have more moderate returns but still generally higher than plain saving.
A 10-year Kenya government bond might yield ~12% per annum, which is higher than deposit ratestatista.com】. But even government bonds have interest rate risk (their market value fluctuates with interest changes) and inflation risk (if inflation soared beyond the bond rate, the real return drops). Still, they are considered among the safest investments return-wise. -
High-Risk Investments: e.g., Stocks of small or volatile companies, real estate in speculative locations, commodities, venture investments, etc.
These can swing widely. You might earn 20%+ returns or you might lose a good chunk. For instance, someone who invested in a startup might double their money or might end up with nothing if the startup fails.
At the extreme, speculative trading (like day trading forex) can either give big gains or wipe out your capital quickly – essentially very high risk for the chase of very high return.
The key idea is diversification reduces risk without proportionally reducing return. By investing in a mix of assets (some risky, some safe), you can improve your overall risk-return profile (this ties into Managing Risks – Diversification in the next section). For example, a portfolio that is 70% in a stock index fund and 30% in bonds might yield a solid long-term return but with less volatility than 100% stocks.
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Volatility (Ups and Downs): Savings have near-zero volatility – your KSh 10k in the bank will be KSh 10k tomorrow (plus maybe a little interest monthly). Investments can be volatile – your KSh 10k in stocks could be 9k or 11k next month depending on market moves.
Over time, volatility averages out (and historically markets trend upward), but in the short run, the ride can be bumpy. Risk in investing is often referring to this volatility and the possibility of permanent loss if one sells or if an asset fails. -
Returns Over Long Term: Historically, investments like stocks and real estate tend to outpace inflation and give real growth, whereas cash savings barely do.
For example, global studies (and limited local data) show equities might average, say, 8-10% above inflation over decades in developed markets. In Kenya, the NSE has had years of high growth (like when Safaricom or KCB grew significantly) and years of decline. Real estate in urban areas has often outstripped inflation, especially during the 2000s-2010s boom.
The trade-off is you must stay invested through the cycles to realize those average returns, and not panic in down years. -
Capital Protection vs Capital Growth: With saving, your capital is protected (in nominal terms; 100k remains 100k). With investing, you aim to grow capital (100k to 150k), but you must accept periods where capital might be lower than what you put in (maybe down to 80k at a point before rising).
From a risk-return perspective, an ideal financial plan takes a balanced approach: Keep enough in safe savings to cover emergencies and short-term needs (so you’re not forced to sell investments at a bad time), and put the rest in investments suited to your goals, knowing they should, over the long run, return more. This way, you cover both bases: low risk for money that cannot be risked, and higher return pursuit for money that can be given time to grow.
It’s also important to assess personal risk tolerance as mentioned. If the stress of seeing your investment fluctuate is too much and might cause you to make rash decisions, you might allocate more to lower-risk avenues. Better a slightly lower return than bailing out of an investment at the worst time due to panic. For instance, during the March 2020 COVID-triggered market crash, those who sold their stocks in panic locked in losses, whereas those who held on (accepting short-term pain) saw markets recover and reach new highs later. That’s the risk-return trade-off in action.
In summary: Savings = low risk, low but stable return. Investing = higher risk, potential for higher return but with ups and downs.
Both have a role, and understanding this helps you decide how much to allocate to each and what kinds of returns to expect. It’s often advisable to seek returns that at least beat inflation for long-term money, which usually requires investing in some form.