Whether you have an established financial plan or are just starting to think about how to put your money to work, remember the differences between saving and investing. These terms are often used interchangeably, but they represent different approaches to your personal finances.
You want to consider bothsavingsIninvestmentat different times in your life, but the key is to understand the pros and cons of each and how they fit into the bigger picture of your financial journey.
Key learning points
- Understanding the purpose of saving and investing can help you make informed financial decisions.
- Factors such as time horizon, risk tolerance and financial goals can influence your choice to save or invest.
- Saving offers low risk and quick access to funds, while investing offers the opportunity for higher returns and capital growth.
- To determine the right approach, evaluate your personal financial situation, goals, and comfort with saving and investing.
Insight into saving and investing
Saving refers to setting aside cash in a low-risk, low-return environment. This can be traditional or onlinesavings accountI bank,money market accounts,certificates of deposit (CDs), or even a situation where you hold cash outside of a financial institution.
Money in any of these institutions is moreliquidthan cash in most types of investments, meaning you can access it more quickly and easily when needed for emergencies or short-term goals.However, in exchange for bearing a lower level of risk than investing, these methods of saving money also offer a smaller reward – in this case, they offer lowerreturns.
Investing your money means buying one of several investment instruments with a higher valueriskand possibly higher pay. Investments can include stocks, bonds, exchange-traded funds (ETFs), commodities, real estate and more.
Not all investment vehicles carry the same level of risk and return.Some, like bonds, can take months or even years to reach maturity.
Likewise, there are many ways to access investments, including through retirement accounts, mutual funds, individual stock trading, and more. Regardless of the type of investment or its specificityrisk and reward profilethe goal of all investments is the same: to grow your wealth in the long term.
Factors to consider when deciding whether to save or invest
Both saving and investing involve putting money aside now for a future goal or expense. However, the time horizon, risk level and most relevant financial goals vary depending on whether you want to save or invest your money.
Taking a closer look at each of these factors can help you decide what to prioritize:
Tijdshorizon
One of the biggest considerations when deciding whether to save or invest is...time horizonof your financial goals. Some goals have a limited scope or a specific endpoint. In these cases, it may make the most sense to keep your money readily available in a savings account or similar vehicle, as you won't hold the money long enough for it to grow significantly in an investment context.
Bradley Baskir,vice president and financial advisor at Morgan Stanley in Boston, says saving is typically preferred "when the time horizon for liquidity is less than 12 months." He adds that saving for short-term goals by "putting that money in a savings account can make more sense than investing it, because [you] can trust that the money will be there" when the goal is achieved.
On the other hand, other financial goals may be more meaningful or open-ended. If you're planning to retire, you're probably thinking years or even decades ahead. These types of long-term objectives benefit from an investment-oriented approach. The longer time horizon for these priorities means that your money has the opportunity to grow significantly when invested, and it doesn't need to be liquid until you're close to reaching the goal at some point in the future.
Risk tolerance
Another important factor in deciding whether to save or invest is yoursrisk tolerance. Risk tolerance refers to the degree of risk you are willing to take given the potential volatility of a financial decision.
Saving your money is less risky than investing. When you invest your money, you run the risk of losing your principal or initial investment.
Consider a situation where you are looking forward to a long-term financial goal. Given the time horizon alone, you might be inclined to assume that investing is the best approach. But if you also face uncertainty about the stability of your job, or there are consecutive periods of itvolatilityin the market, or if you are otherwise unsure of what your financial situation will be, it may be safest to put your money in a savings account.
Each person has a different onerisk tolerance, which is different from the individual's risk capacity or ability to take risks. Your risk tolerance may depend on factors such as your age, financial goals and income, among other things.
Financial goals
Explains it clearlyfinancial goalshelps you decide when it is wise to save or invest – or a combination of both. Financial goals can be big, such as preparing a down payment for a house, a new car, college tuition, or planning for retirement. They can also be more modest, such as saving for a small purchase or a short weekend getaway.
The nature of your financial goals will influence your decision to save or invest. If your goal requires quick access to cash, you'll likely choose to keep the money in a savings account or similar liquidity.
On the other hand, if you are hoping for a better return on your money than savings accounts and can be achieved over a longer period of time, then investing may be the answer.
Many financial advisors recommend setting one asideemergency fundin a liquid account before considering investing.
Advantages and disadvantages of saving
Savings offer security, but lower potential for rewards.
Benefit
Saving your money involves low risk.
Some savings methods are insured by the Federal Deposit Insurance Corp. or the National Credit Union Administration.
Savings and similar accounts usually make it easy to access your money.
Easy to use; most of these accounts do not require regular maintenance or observation.
Cons
Lower potential return compared to investing.
There is a risk that savings accounts cannot keep up with the paceinflation, your purchasing power erodes in the medium and long term.
Advantages and disadvantages of investing
Likewise, investing offers both advantages and disadvantages. Baskir notes that “investing is by nature a trade-off between risk and return, so those willing to stay the course in avaried portfolioover longer periods of time, in any market environment, should be rewarded with returns greater than those of the cash equivalents earned through savings alone.”
Benefit
Investing provides a (significantly) higher return than saving. As your investments grow, you can leverage themcompoundto accelerate profits.
Investing offers many different entry points and strategies, from individual stocks and bonds to mutual or exchange-traded funds.
Investing your money allows you to buy companies, industries and sectors that interest you or that you support.
Cons
In some cases, investments are less liquid than savings. It may take longer for you to access your money and this could potentially cost you money, such as in the case of early withdrawals from retirement accounts.
Markets for stocks, commodities, real estate and other assets are often very volatile, meaning you may not make a profit and could even lose some of your principal.
Some approaches to investing are very practical and require both time and specialized knowledge.
Investors are subjectprejudicesInemotion baseddecision-making, which could negatively impact their investments.
Determining the right approach
Baskir says that 'saving is to running what investing is to running.' He adds that it's important to have "enough saved for a rainy day, usually equivalent to three to six months' worth of expenses in case of layoff, health problems" or other unexpected changes in a financial situation, before investing.
Consider this checklist to determine the best approach for you:
- Do you have enough money to cover three to six months of fixed costs? If not, start saving.
- Do you have other short-term goals that require quick access to cash (such as travel plans)? If so, start saving.
- Are you on track to achieve your retirement goals before the desired age? If not, start investing.
- Do you understand the risks associated with investing this money for a long-term goal such as retirement? You may not be able to access it until age 59.5 without tax and penalty, and you run the risk of volatility, etc.
- Are you comfortable waiting before accessing your money to take advantage of compounding? If so, you may want to start investing.
- Are you comfortable with your current monthly distribution of your savings and investments? Where do you feel like you're falling short?
Savings versus investment: example
Let's say you're in your late 30s, single, and earning a six-figure income. Currently, you have about two months of savings and just over a year's salary in your company-sponsored 401(k). You also recently paid off your student loans and have $500 to spend on your other financial goals, including:
- Increase your emergency fund to cover at least three months of expenses
- Increase your retirement savings to ensure you can retire at age 67 with an income that meets your needs
- Set aside extra money for travel
The amount you decide to contribute to each category depends on your priorities. It can also be changed; For example, you may decide that setting up an emergency fund to cover three months of short-term expenses is most important. Once that goal is funded, you can move on to putting more money toward retirement (and fun).
When to save
Savings may be the best option for you if you haven't set up a rainy day fund yet, if you have a short-term financial goal, if you expect to need access to your money at short notice, or if your risk tolerance is low and you want to protect your client.
Choice savings account
Today, there are a variety of savings accounts available, including traditional accounts, online-only accounts,high yield accounts, money market funds and much more. Look atInvestopedia's in-depth guidefor an overview of many of the most popular savings account options and suggestions for choosing the right account for you.
When to invest?
Investing may be the best choice for you if you already have an emergency fund and if you are planning a long-term financial goal, if you are looking to earn interest on your money, if you have the flexibility to spend your money in a less accessible way to preserve. account, or if you have a higher risk tolerance.
Brokerage account selection
Choosing a way to invest your money can be a much more complex matter than choosing a savings account. Most novice investors will use onebrokerage accountto facilitate transactions. Many of the leading brokers offer an easy-to-use interface, free trading in certain cases, and access to a variety of assets including stocks, mutual and exchange-traded funds, and more.
It's worth thinking about the ways you plan to invest – actively or passively, what types of asset classes you want to focus on, etc. – and using themInvestopedia's guide to choosing a broker.
What are the benefits of saving money instead of investing?
Some of the advantages of saving over investing include a lower level of risk, easier access to your money, and a relatively simple process.
What factors should be taken into account when choosing between saving and investing?
Remember your financial goals – big or small, necessary or discretionary – and what the time horizon is for those goals. Your risk appetite is also important. You can also set aside some of the money for savings and some for investing to achieve both short- and long-term priorities.
Can you save and invest at the same time?
Absolute. Advisors recommend that individuals set aside several months' worth of emergency funds in a savings account or a similar liquid option before considering whether to invest additional money. In addition, you may consider saving for certain financial goals while also investing in efforts to achieve other goals.
In short
Saving and investing are sometimes used interchangeably, but they represent different ways to spend your money. Saving refers to keeping your money in a low-risk, low-return savings account, CD, or money market account, while investing refers to buying and selling stocks, bonds, ETFs, mutual funds, commodities, and/or real estate.
Savings are generally seen as preferable for investors with short-term financial goals, low risk tolerance, or investors who need an emergency fund. Investing may be the best option for people who already have a rainy day fund and are focused on long-term financial goals, or for those with a higher risk tolerance.
