If you expect a higher rate of return on your savings then you need to take on more risk. Generally speaking, the risk is the potential of your investment to fluctuate in value over a period of time. It is important to realise how risky your investments are relative to their returns. What tends to smooth out the swings in valuations is the time that you invest. So if you save in risky investments then you need to commit for a longer period. On the other hand, saving in less risky investments will not produce the same rates of return.

 To help you understand where you should be investing over time relative to the risk, here is a simple investment spectrum which provides a broad brush on where to save:

These investments are very low in risk and provide more certain returns.

Debt – Don’t ignore this opportunity before committing. It is the most certain investment. You know what you are paying off and the exact interest you are saving. The effective rate of return is the interest you are being charged.

Savings accounts

Money market accounts

RSA retail bonds

These investments need this time period to compensate for the fluctuations and to compound their returns.

Property exchange-traded funds

Balanced funds – unit trusts

These investments have a high probability of big swings in their valuations in the shorter term and therefore need a longer time to smooth out. They tend to provide higher rates of returns over time so need a longer view.

Equity Unit trust and exchange-traded funds

Shares – direct portfolios

Ideally, you need to invest over all these time periods to provide for the various savings needs in your life. Your investments should be aligned to your appetite for risk.

If you are living at home with the folks, then you should be saving a lot more than if you are living on your own. You should work out your actual cost of living, and see how you can manage the expenses. Stay away from debt and leave behind as much as possible for savings. Get the cash account for emergencies in place first and then onto the investments for the longer term.

You should save all the time. Short-term savings targets for things like deposits on cars, and holidays. Long-term savings for your retirement.

Your time horizon determines how much you can afford to invest in more risky assets such as shares. You see, shares tend to outperform other assets over time. They do not perform in straight lines. They are volatile which means that their valuations can move up and down in a very short space of time. This volatility smooths out in the performance of shares over a longer time horizon. So, if you can invest for the long term, then shares become a more appropriate option. Generally speaking, this should be a period of 10 years or longer.

A sound financial plan has a provision for emergencies. This should be a cash savings account which is easily accessible and earns some interest. Ideally, a money market account with your local bank. The amount saved should cover you for 6 times your monthly income need. Why? Well, if you need to access cash for an unforeseen expense then this account is available instead of you having to cash in your investments which are set for the longer term. It buys you peace of mind that even if you lose your job you have some time to find a new one.