Wondering whether you should Investing or saving? The answer depends on your goals and your financial situation.
Saving and investing are both important concepts for building a sound financial foundation, but they’re not the same thing. While both can help you achieve a more comfortable financial future, you know the difference to enable you to decide which is better for you.
The biggest difference between saving and investing is the level of risk taken. Saving typically results in you earning a lower return but with virtually no risk. In contrast, investing allows you the opportunity to earn a higher return, but you take on the risk of loss to do so.
Here are the key differences between the two — and why you need both of these strategies to help build long-term wealth.
Saving vs. investing
Saving is the act of putting money aside, bit by bit, for a future expense or need. When you choose to save money, you want to have the cash available relatively quickly, perhaps to use immediately. However, saving can be used for long-term goals as well, especially when you want to be sure you have the money at the right time in the future.
Savings can be stashed away in the form of cash or a bank account, so little or no risk is involved. You can save up to pay for something specific, like a holiday, a deposit on a home, or cover any emergencies that might crop up, like a broken boiler. Saving usually means putting your money into cash products, such as a savings account in a bank or building society.
Investing money is the process of using your money or capital to buy an asset that you think has a good probability of generating a safe and acceptable rate of return over time. The goal of investing is to make you wealthier, even if it means suffering volatility, perhaps even for years. For example, you might invest in stocks, property, or shares in a fund.
Is there really a difference between saving and investing?
Most of us think that saving and investing are the same thing. While the terms are often used interchangeably by many, they are as different as chalk and cheese. The difference between your monthly income and your expenses is what constitutes your “savings.”
But when you multiply the money you save by putting it in various asset classes such as stocks, bonds, real estate, or gold, you are creating wealth by “investing.”
Joseph puts money aside regularly. He spends less than he earns and deposits the rest in the bank. This is saving.
John goes a step further. He puts aside a fixed amount every month in mutual funds. This is investing.
The pros and cons of saving
There are plenty of reasons you should save your hard-earned money. For one, it’s usually your safest bet, and it’s the best way to avoid losing any cash along the way. It’s also easy to do, and you can access the funds quickly when you need them.
All in all, saving comes with these benefits: There are plenty of benefits to saving rather than investing. First, the dollar amount you save in a savings account won’t decrease over time as long as you don’t make withdrawals. This is important because some goals need to happen regardless of whether investment prices are up or down.
Saving rather than investing also allows you to reach your goal on time as long as you save the proper amount each month. Take the total you need to save and divide it by the number of months until you need to reach your goal to find the amount you need to save each month.
Saving is generally straightforward and easy to do. There usually isn’t any upfront cost or learning curve.
Despite its perks, saving does have some drawbacks. Saving does have downsides, though. Due to inflation, the money you save will decrease in value each year. If you earn interest, that interest may partially offset the negative effect of inflation. Unfortunately, interest rates rarely keep up with the rate of inflation.
Saving also means you’ll have to set aside more money each month than you would if you received higher returns investing. If you’re only earning 1% interest in a savings account but could earn an 8% return investing, you’ll have to make up for that 7% difference by putting more money in your savings account to reach your goal at the same time.
The pros and cons of investing
Investing can be beneficial, too. Investing gives your money the potential to grow faster than it could in a savings account.
If you have a long time until you need to meet your goal, your returns will compound. Basically, this means that your investment earnings will also earn money over time in addition to a higher rate of return on investments.
The benefit of higher compounding returns is you won’t have to invest as much each month as you would need to save each month from reaching your goal.
While there’s the potential for higher returns, investing isn’t always a good thing though. Investment prices could go down right before you need the money, which could leave you in a financial bind.
If this happens, you will have to either settle for an option that doesn’t cost as much, delay your goal until you can save more money, or delay your goal until your investments increase in value.
How Much Should I Save vs. Invest?
Saving money should almost always come before investing money. Think of it as the foundation upon which your financial house is built. The reason is simple: Unless you inherit a large amount of wealth, your savings will provide you with the capital to feed your investments.
If times get tough and require cash, you’ll likely be selling out your investments at the worst possible time. That is not a recipe for getting rich.
As a general rule, your savings should be sufficient to cover all of your personal expenses, including your mortgage, loan payments, insurance costs, utility bills, food, and clothing expenses for at least three to six months. That way, if you lose your job, you’ll be able to have sufficient time to adjust your life without the extreme pressure that comes from living paycheck to paycheck.
Any specific purpose in your life that will require a large amount of cash in five years or less should be savings-driven, not investment-driven.
So which is better – saving or investing?
Neither saving or investing is better in all circumstances; the right choice really depends on your current financial position.
Generally, though, you’ll want to follow these two rules of thumb:
- If you need the money within a year or so or use the funds as an emergency fund, savings is your best bet.
- If you don’t need the money for the next five years or more and can withstand some capital losses, you likely should invest the money.
And when is investing better?
Investing is better for longer-term money — money you are trying to grow more aggressively. When you can keep your money in investments longer, you give yourself more time to ride out the inevitable ups and downs of the financial markets. So, investing is an excellent choice when you have a long time horizon (ideally many years) and won’t need to access the money anytime soon.
If you have short-term goals, save
First, if you absolutely need the money by a certain date, save rather than invest. With saving, there is no risk of your balance decreasing. On the other hand, investments can decrease in value.
If you have long-term goals, invest.
Next, investing provides an opportunity to get greater returns if you have a long time horizon and can delay your goal if things don’t go as planned.
The key is being able to delay your goal. If investments are down when you originally planned to reach your goal, delaying by a couple of years could result in your investments returning to a higher value.
Or Do Both
Of course, you can mix saving and investing, too. You can save the money you absolutely need and invest the money that would be nice but isn’t necessary to meet your base goal.
Another option is investing toward the beginning of a long-term goal and slowly switching to saving as your goal gets closer. This helps avoid a sudden drop in your investment values that could delay your goal.
Ultimately, it’s up to you to decide whether saving or investing is the better choice to reach your financial goals. And, of course, how and whether you invest, save, or do a combination of both will more than likely continue to shift over the years as your priorities and goals change.