For many people, saving comes before retirement — but when they see the returns they're getting from their savings, the more adventurous often decide to make the leap into financial investments.

If you put money aside in a cash account, which earns a fixed rate of interest and doesn't drop in value except through inflation or devaluation, you're saving, not investing.

When you make a financial investment, you buy tradable financial instruments (shares, bonds, and other paper assets — including foreign currencies) with the intention of gaining profitable returns in the form of interest, income or growth in the value of what you've bought.

And that can be through shares in a company, government or corporate bonds, a share in commercial property or even a futures contract for coffee.

Limited liability

Company ownership of assets, such as property, machinery or factories, encourages shareholders to invest.

First of all, a company is set up as a ‘separate person' under the law. The company enters into all legal agreements and contracts, and is responsible for profits or losses, rather then the owners of the company — the shareholders.

These shareholders are limited in their liability for losses to the amount that they have invested in the company but, crucially, they are not limited in how much they can share in the company's growth and profits.

This important development separates ownership of the company from liability for its debts.

Double benefit

Shareholders are not lenders, but owners of part of the company. In return for their investment, they can receive dividends, and they can also sell on their shares to other investors.

So if a company does well, shareholders get a double benefit — the value of their dividends, and the increased value of their shares. That's why the return on shares over the long-term has substantially outpaced inflation, the growth in pay and what you can get from savings.

Investments and savings

Consider this example from the United Kingdom: £100 (Dh584.67) invested in 1950 and invested in a regular bank account would be worth £1,560 in 2010. However, to buy the equivalent basket of goods that one could buy with £100 in 1950, you would need £2,680: inflation has significantly outstripped the return on cash.

That £100 invested in 1950 would have grown to £6,146 if it had been invested in UK gilts (government bonds) with the income reinvested and a whopping £117,500 if invested in UK equities with the income reinvested.

However, to gain access to such returns you have to accept that it could be a bumpy ride. The markets will fall and sometimes they will be depressed for a prolonged period of time. In fact, we've just been through and are probably even still going through a period of prolonged stock market volatility and asset price falls — the ‘lost decade', as some are calling it.

However, this does not mean that you are going to lose your investments! If your portfolio is down when you check online or your adviser comes to see you, this only represents the market value, a paper loss can only be realised when surrender is made.

 

The writer is senior consultant at Acuma Wealth Management, Dubai. The opinions expressed here are his own and do not reflect those of Gulf News.