A sound financial plan should include both saving and investment. While investing has the potential for higher long-term returns and can assist reach long-term financial goals, saving offers a safety nett and a mechanism to accomplish short-term objectives.
Saving vs investing: How to Benefit from Both Strategies?
Saving vs investing: 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, consumers need to know the differences and when it’s best to save compared to when it’s best to invest.
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 in order to do so.
Saving is your first step in forming good financial habits and having money to put toward investing once you’re ready. But in order to grow your wealth for your future—for things like retirement, vacations, education, kids, etc. you need to learn to invest. Here, I’ll cover the pros and cons of saving vs investing, why you need to do both, and how much to save vs invest depending on where you’re at in your financial journey.
What’s the Difference between Saving vs Investing?
I mentioned at the start that the main difference between saving and investing is that saving stores your money while investing grows it. Doing both is not just good, but essential.
Having a safe place to store your money, i.e., in a savings account, ensures it’s there for you in case of an emergency, to be used for regular big purchases, or until you’re ready to invest.
Another big difference between saving vs investing is the perceived risk. With saving, there is somewhat little to no risk of having less than you started with… but I’ll get into that more in a bit.
With investing, there is a risk that you will lose some or all of your initial investment. On the flip side, there is little to no chance that you will make any money off of your savings account, but, if you invest wisely, there is a good chance you will make money off of your investments.
To understand these differences and how they impact your life, let’s explore how saving vs investing works.
What is Saving?
Saving products include standard saving accounts, money market accounts, and certificates of deposit (CDs). Each of these products, which are offered by most banks, is a safe place to hold your money.
They all also offer some level of interest on the money held in the account. CDs offer the highest amount of interest of the three but also restrict access to your money for a few years; the longer the timeline, the greater the interest rate.
Regular savings accounts typically offer very little in terms of interest, usually less than 1%, however, this rate fluctuates from bank to bank and is influenced by the interest rates set by the Federal Reserve.
The interest you earn through saving is one of the main reasons I advise Rule #1 investors to not store too much of their money in a savings account for too long.
Over time, the money held in a savings account loses value because the interest rate cannot keep up with the rate of inflation—and this is what I meant when there’s somewhat no risk of having less than you started with.
There is such thing as a high-yield or high-interest savings account as well, but even these accounts don’t beat the rate of inflation. So while your money may be “safe,” it’s losing value day by day.
What is Investing?
There are many different types of investments, including stocks, bonds, mutual funds, ETFs, real estate, and so on. Each type of investment carries some level of risk.
Typically, the greater the risk, the greater the potential for substantial gains or losses. Of these types, bonds are the least “risky” because they’re typically guaranteed by the government, but they also offer the lowest return. Individual stocks, on the other hand, are perceived as the riskiest, but also typically offer the highest return.
With any investment, the level of risk is determined by how much you know about what you are investing in. Only investing in companies or investment products you thoroughly understand by researching them before investing, only then you can do so with a higher margin of safety.
By following this strategy, you can greatly reduce the risk of investing, easily beat inflation, and substantially increase your net worth.
When to Save vs Invest your Money
While investing is an optimal long-term strategy, there is a time and a place to save, especially if you’re in a tough spot financially or just starting out. If this is you, take two to three years to build up your savings.
When to Save your money
Financial advisors say that having a financial cushion for emergencies should always be your first priority.
Saving is a smart first move if:
- You don’t yet have emergency savings. “Save first!” says Danna Jacobs, founding partner at Legacy Care Wealth with offices in Jersey City and Morristown, New Jersey. She recommends setting aside at least one month of living expenses before diving into most investing; even $500 is a good buffer against an emergency car repair or doctor visit
- You need the cash within five years. Maybe you have emergency savings and you’ve set your sights on another goal: a house down payment, for example. Or maybe you’re saving for an annual car insurance premium. Either way, shorter-term savings should stay in a savings account, where returns are guaranteed, and not be invested in the stock market.
When to invest your money
Ideally, investing money for the long term — we’re talking mostly about retirement — happens at the same time as saving. But sometimes investing has to take a back seat, with one notable exception:
- You’re eligible for a Superannuation match. If your employer offers a superannuation or other workplace retirement savings plan, it might also match a percentage of your contributions — up to, for example, 4% or 6% of your salary. This is free money, but the only way to get it is to sign up and contribute to the account. Unless someone truly can’t pay their bills, Jacobs almost always suggests saving enough to get the full match.
You can start saving in a superannuation account even if you’re still starting an emergency fund, says Mike Morton, founder of Morton Financial Advice. “If you can set aside, say, $100 a month, do a 50-50 split” between your superannuation and savings, he says.
Consider investing more money if:
- You have a topped-up emergency fund — or you’re making good progress. Jacobs likes to see clients on track to have theirs fully funded within the next two to three years before prioritizing investing. Three to six months of living expenses is just a starting place; shoot for more if you’re self-employed or are a single-income household, for example.
- You’ve paid off high-interest debt. Student loans and mortgages often have low interest rates, and you can feel comfortable paying the minimums in most cases, Morton says. But when it comes to credit card balances and other high-rate debt, think about the return, Jacobs says: “It does not make sense to pay 20% a year to carry a credit card balance of $5,000 and then invest $5,000 and get a 7% return.”
- You have long-term goals that will require a lot of cash. These are expenses that won’t come due for at least five years. Retirement is a big one, or a college fund for younger kids.
Which is Better – Saving or investing your Money?
That really depends on your risk tolerance, financial requirements, and when you need to access the money. Investing has the potential to generate much higher returns than savings accounts, but that benefit comes with risk, especially over shorter time frames.
If you are saving up for a short-term goal and will need to withdraw the funds in the near future, you’re probably better off parking the money in a savings account. Conversely, if your goals are longer-term, you’ll generally find you can obtain more satisfactory results from investing.
It’s important to both save and invest, and learn how to do so early on. If you can master these financial habits, you can set yourself up for an incredible financial future.
How Much Money to Save
One popular guideline, the 50/30/20 budget, proposes spending 50% of your monthly take-home pay on necessities, 30% on wants and 20% on savings and debt repayment.
For example, if you make $4,000 after taxes each month, that works out to $800 for savings and paying off debt.
“Savings” is a broad term. So what exactly does it cover? According to the 50/30/20 rule, the savings category consists of an emergency fund, retirement and other long-term savings goals, such as paying for a home or your child’s college education.
Remember, the entire 20% isn’t devoted to savings. Reserve some of that for paying off credit cards and other high-interest debt, if you have it.
Figure out what’s realistic for you
The 20% rule is a good general guide, but it isn’t the right fit for everyone. Some people can save above that rate, while others merely struggle to make ends meet.
“Some people pay their rent and they have nothing left. So how are they possibly going to save 20%?” says Tara Unverzagt, a certified financial therapist and certified financial planner in Torrance, California? “You need to look at your situation to see what is reasonable and what’s not reasonable.”
You can use a budget planner to compare your estimated monthly spending and saving totals with the recommended 50/30/20 budget figures. Don’t feel ashamed if you’re saving below the suggested rate or nothing at all. There may be ways to save, make or even stop spending money that can help you increase your savings contributions. For example, cancelling a rarely used gym membership could free up around $40 or $50 every month.
Your income, expenses and goals should ultimately determine how much you’re able to save each month. “If the goal is to retire at 40, you need to save a heck of a lot more than people who are shooting for 65 because you have 25 fewer years for that money to compound,” says Tess Zigo, a CFP in Palm Harbor, Florida.
How Much Money to Invest
One of the most common things people ask when they start planning for their future is: How much of my income should I be investing?
If this sounds familiar, kudos to you for looking ahead. Investing not only helps you build wealth, but it also secures a nest egg for when it’s time to retire. While you don’t need much these days to start investing, the key is that you regularly contribute beyond your initial deposit so that you have more money to grow over time.
But just how much of your income should go toward investing? The sweet spot, according to experts, seems to be 15% of your pretax income.
Matt Rogers, a CFP and director of financial planning at eMoney Advisor, refers to the 50/15/5 rule as a guideline for how much you should be continuously investing.
According to the rule, 50% of your take-home pay should be allocated to essential expenses (housing, food, health care, transportation, child care, debt repayment), 15% of pretax income (including employer contributions) gets invested for retirement and 5% of take-home pay is used for short-term savings (like an emergency fund). This leaves 30% of your income that can be used for discretionary expenses, like entertainment and dining out, or more savings.
The 15% rule assumes investors start early in their career. A good place to begin getting to 15% is by making sure you are contributing enough to meet any 401(k) employer match, if your company offers one.
“If young workers struggle to achieve the 15% goal immediately, it’s important for them to save as much as possible and increase contributions by one or two points as they earn more income,” Rogers tells Select. Many employers will automatically increase your contribution annually, so look to see if that is an option for you.
Summary
Saving vs Investing, its Ultimately up to you! 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.
