Saving and investing are crucial for financial success and should be implemented into anyone’s financial plans. Saving money focuses more on achieving short-term goals, while investing is more suited for achieving long-term goals because of the long-term returns that investors can experience as a result. While investing gives people the chance to experience long-term financial growth, there’s also the risk of losing money to factors like unfavorable market movements or volatility.
One of the keys to financial planning is balancing your immediate needs with long-term goals. Our guide will further discuss the primary differences between saving and investing as well as how to balance the two to achieve the best long-term stability possible. Each of these concepts serves different purposes in achieving financial goals, and we’ll pore over these in great detail to give you a good understanding of how all this can come together to your benefit.
Defining Saving and Investing
The primary difference between saving and investing is the level of risk involved and the time involved for each activity. Saving money is lower risk and lets investors access their money quickly and easily, while investing comes with higher risks but a chance and some excellent gains long-term. Let’s dive into the characteristics of both saving and investing, plus some good examples to get across the point.
What Is Saving?
Saving is the act of setting aside money for short-term goals or emergencies, rather than using it might away. Some short-term goals might include saving for new appliances, a new phone, or gifts for friends/family. There are also long-term goals like saving for a new car or your first house. Saving can also be done for unexpected expenses like medical bills or repairs on your home or vehicle.
Characteristics
- Low Risk — Compared to investing, saving is a less risky endeavor. Many savings accounts offer low interest, and there isn’t any chance of losing your money due to unfavorable market movements or volatility. Your money sits in an account and isn’t subject to any sort of loss, that is, unless you withdraw the money and spend it.
- Easy Accessibility — The great thing about money that’s sitting in a savings account is that it can be easily withdrawn by the owner, either through online banking transfers, an ATM, or a debit card. It’s easy to access quickly in the event of an unplanned expense or emergency.
- Minimal Returns — You might earn some minimal interest in a savings account, but save money largely sits waiting to be used. Investing money will produce much more significant returns, as you’ll see in the next section.
Examples
- Savings Accounts – This refers to a deposit account that lets you earn interest on your money while keeping it safe and accessible. These savings accounts are usually held at a bank or credit union. They can be used to save for short-term or long-term goals.
- Money Market Accounts – This is a deposit account that has combined features of checking and savings accounts. Not only can you access your money easily using money market accounts, but you can also earn interest on your balance. These accounts pay higher interest rates than savings accounts.
What Is Investing?
Investing is when you purchase assets with the goal that they’ll either generate income or appreciate. The main goal of investing is to earn a return that exceeds the amount of the initial investment. These include assets like stocks, bonds, cash, or real estate. Investing can be simply defined as allocating money to assets to grow wealth over time.
Characteristics
- Higher Risk — There’s the likelihood of investors losing their money due to factors like financial stability within a company, lack of liquidity, or market downturns which could cause investments to lose their value. You don’t have any of that with money that’s sitting in a savings account.
- Long-Term Potential — Investing is a terrific way to meet long-term financial goals because money that’s tied up with long-term investments can grow as assets appreciate in value over time. If investors are making the correct moves and keeping their money invested with the winners, they stand to earn quite a bit of money over time.
- Diversified Returns — As long as investors have their positions diversified across multiple sectors and asset classes, they don’t have to worry when a few investments go down in value. They can simply use their other investments to mitigate those losses and keep their portfolio steadily growing.
Examples
- Stocks: Also known as equities, stocks are a type of security that represents a stake in a company. Essentially, it’s a share of ownership in the company. Stocks can be bought and sold at stock exchanges.
- Bonds: These are loans to a company or government that pays interest to investors over time. They are generally seen as a safer investment than stocks due to the fact that their value is far less volatile.
- Mutual Funds: These are investment companies that pool money from many different investors to buy a wide range of short-term debts, stocks, or bonds. To asset ownership in the fund and its income, investors buy shares in the mutual fund.
- Real Estate: This refers to purchasing real estate with the goal of making a profit. Investors can make money in a wide range of ways, including rental, sale of the property, or management of the property.
Purpose and Goals of Saving vs. Investing
Now let’s discuss the goals and purposes behind both saving and investing money. Both are intended to help people reach their financial goals, be they short-term or long-term. As we dive into the differences, it will be clear what separates saving from investing, but also the importance of using both together for maximum effect.
Purpose of Saving
- Building an Emergency Fund: One of the primary purposes of saving money is to have funds set aside in the event of unforeseen expenses or emergencies. Having saved money can help in the event of an injury, vehicle or home repairs, or being short of money between paychecks.
- Saving Short-Term Goals: Saving is a great way for people to achieve short-term financial goals, like making a down payment on a new home or for a vacation.
- Maintaining Liquidity for Unexpected Expenses: One of the best parts of saving money is having the cash available on hand to deal with unexpected expenses instead of resorting to credit. People don’t have to take on extra debt in addition to whatever ordeal they’re dealing with.
Purpose of Investing
- Growing Wealth Over Time to Outpace Inflation: By investing your money in assets that have the potential to produce returns that keep ahead of inflationary changes, you can grow wealth regardless of the condition of the economy and inflation, which devalues the money.
- Building a Retirement Nest Egg: Investing can be a great way for people to save money for their retirement. In addition to any 401(k)s, pensions, or IRAs that someone might have set up for themselves while they worked, they can use money earned from investments to supplement their retirement savings.
- Achieving Long-Term Financial Independence: Investing means that you can accumulate assets that have the potential to produce enough income to cover your experiences long-term. These passive income investments are key for many people looking for financial stability and independence.
Key Differences between Saving and Investing
To further illuminate the differences between saving and investing money, we’ve put together the following table to break down the differences in the most basic terms. If you’re looking for some quick answers, this should sum everything up quickly. Read our entire guide for a detailed breakdown explaining each form of putting your money to work for your goals.
Aspect | Savings | Investing |
|---|---|---|
Time Horizon | Short-Term | Long-Term |
Risk Level | Low | Medium to High |
Returns | Predictable and Minimal | Variable + Potentially High |
Liquidity | High | Medium to Low |
Tools/Products | Savings Accounts and CDs | Stocks, bonds, ETFs, etc. |
How to Choose Between Saving and Investing
Ideally, you should be using saving and investing together to achieve your short-term and long-term financial goals, but there are times when you should use one over the other. This section of the guide will address when it’s appropriate to choose saving over investing and vice versa. We’ll talk about the importance of assessing your financial goals, understanding your risk tolerance, and evaluating your financial situation, then using these concepts to determine if saving or investing is more appropriate.
Assess Your Financial Goals
Determine short-term and long-term goals. Generally, you’ll use saved money to achieve your short-term goals, while investing is more suited for long-term goals as investing takes time for profits to be realized. It’s key to figure out what’s important right now and determine whether saving or investing is most appropriate, then move on to the next goal with the next appropriate measure.
Part of assessing your financial goals is to prioritize your needs, both short-term and long-term. Use a checklist to clarify priorities such as emergency fund, retirement, or house purchase. It’s best to be current on your bills and have an emergency fund in place before moving on to bigger goals such as purchasing a home or saving up for your retirement.
Understand Your Risk Tolerance
Taking your risk tolerance into account is key in choosing between saving and investing. Some people aren’t as open to risk as others, so saving is probably the best fit for people with that level of risk tolerance. However, to make headway with long-term goals, people will need to open up to investing as a vehicle to reach these objectives, unless they have enough income where they can save enough to meet their needs or goals.
While saving is ideal for risk-averse individuals or short-term needs, investing is the better option for long-term growth and is best for investors who are comfortable with market fluctuations. If your risk tolerance is higher, investing is a great way to meet your long-term goals, while you can still save to achieve short-term objectives. Investing long-term can produce some significant returns, so those with a low risk tolerance could be missing out on growth opportunities.
Evaluate Your Financial Situation
As we mentioned before, it’s best to have your bills caught up and a savings account in place for unplanned expenses or emergencies before you should consider investing. Evaluate your financial situation. Do you have enough money coming in and set aside where you’re covered in case of an emergency? If you can say yes to that question, then you’re probably okay to begin setting money aside for investments.
Use a 50/30/20 budgeting rule for guidance. This means that you should use 50% of your money for needs and obligations such as housing, food, or clothing. 30% can be used for wants like vacations or entertainment. 20% is dedicated toward savings or debt repayment. We recommend this guide as a rule of thumb, but it might not be for everyone. We’re just saying that you can use this rule to determine if you’re in a financial situation where you can start investing your money.
The Role of Both in Financial Planning
Savings and investing both play a critical role in financial planning. For the best effect, people should be using each and playing into their unique strengths, the savings as a foundation, and the investing as a growth vehicle.
Saving as a Foundation
Many financial planners and advisors recommend that people should have three to six months of emergency funds set aside to prepare for the unexpected events of life. These funds are there if something happens and you cannot meet your obligations when it comes to paying for housing/rent, buying groceries, or paying your bills. In this way, savings are used as a foundation, but it’s not the route to go when it comes to growing wealth—that’s left to investing.
Investing as a Growth Strategy
Compound interest as a way to build wealth refers to allowing interest earned on an investment to earn interest on itself over time and to be added to the principal amount. As investors build wealth through compounding interest, they can better meet long-term objectives like retirement or education funds because over time investing brings in more money in a passive way than saving money does.
How They Work Together
If you’re just starting with financial planning, it’s important to use a breakdown of 70% for saving and 30% for investing. This can be adjusted from one investor to the next, but it’s a general rule that works well for those who are in early-stage financial planning. It’s key to shift allocation as goals evolve. You might want to up the amount that’s dedicated to investing as your reserve of saved money becomes more stable and provides a solid enough foundation.
Common Mistakes to Avoid
Let’s run through some of the most common mistakes that people make when saving and investing for their financial futures. These are mistakes that you’ll want to avoid, and the sooner you can learn from the past mistakes of others, the better off you’ll be as you save money and begin your investing journey.
Saving without a Purpose
While it’s a good habit to save cash as opposed to spending it all the minute you get it, there are some pitfalls to hoarding cash. These include losing your purchasing power due to inflation and missing out on financial investment opportunities. Because some people are afraid of investing, they miss out on investing in assets that could appreciate in value and outpace inflation.
Investing without a Safety Net
It’s best not to invest without an emergency fund in place. First things first: you should have your finances in order and have a buildup of three-to-six months of expenses (recommended) in your savings account before you should consider getting into investing. If you run into trouble with your personal finances and you have to prematurely withdraw your investments, you will be subject to a possible tax penalty, where you have to pay state and federal taxes.
Ignoring Inflation
Inflation erodes the value of savings by reducing the purchasing power of money over time. The real value of a person’s savings decreases if the interest earned on savings doesn’t keep up with inflation. The importance of diversifying your investments into multiple asset classes and sectors is that they work as a great hedge against inflation.
Tools and Resources for Saving and Investing
Check out the best tools for successfully saving and investing your money to meet the short-term and long-term goals you’re hoping to achieve throughout life.
- Savings Accounts: Use high-yield savings accounts where there’s a rate of 4.55 APY or more. Not only are you able to store your money to build the foundation for your success, but you can earn some interest in the process.
- High-Yield Savings Platforms: These accounts offer much better interest rates than the standard savings account. You can grow your money much faster by earning a higher annual percentage yield—get easy access to your money, but also earn even more interest.
- Investment Platforms: These include brokerage accounts and robo-advisors, where investors can pick and choose what they want to invest in or get recommendations from automated advisors on where to invest money.
- Financial Calculators: Investors best use these calculators to plan goals, basically figuring out how much money is needed to reach long-term objectives.
Frequently Asked Questions
Find out what our customers and readers have been asking about saving and investing. We took the most common questions and answered them below to highlight some of the key points discussed in this guide.
How Much Should I Save before I Start Investing?
Many financial experts and strategists recommend that people should have around three to six months’ worth of expenses saved up before they begin to allocate capital toward investments. Remember that saving is primarily for people to establish a solid foundation, and investing is the vehicle that drives growth. This money should be saved up in the event that an emergency occurs or an unforeseen expense crops up, which will cover the investor and not have to cause them to withdraw their investments early.
What’s the Safest Way to Invest as a Beginner?
Mutual and index funds are both good options for newbies and beginners. Whereas investing in stocks requires more fundamental analysis and bonds produce minimal returns to investors, mutual and index funds don’t require as much active monitoring and produce returns that keep investors well ahead of inflation.
How Do I Know if My Investment Risk Level Is Too High?
There are several signs that the risk level of your investments is too high. Once you’ve seen these signs, it’s a good indication that you should bring the level of risk down to a place where you’re more comfortable. These include being so fearful of losses that you’re constantly checking your investments, you are stressed out when there are small fluctuations in your portfolio’s value, or your current strategy involves a large portion of high-risk assets that could greatly jeopardize your portfolio.
Use Both Saving and Investing to Your Advantage
Saving and investing your money are two different things, but each has its own unique role to play in helping people achieve their short-term and long-term financial goals.
- Saving money is a great way to form a solid foundation upon which your financial investments can be built. Saving accounts are a way to store your money in a place where it can earn some minimal interest but is still easily accessible.
- Once you have saved around three-to-six months of expenses for emergencies or unplanned expenses, you can begin investing in assets that can appreciate in value. Investing does the heavy lifting of helping people earn money long-term that outpaces inflation. Investing is better suited for meeting long-term financial goals.
If you aren’t investing right now, we’d encourage you to begin building an emergency fund and starting small with investments. While there are benefits to saving, it’s not going to be the primary tool for pushing growth or creating wealth. Use your saved money as a base and then get into investments to tackle long-term goals like retirement or saving for a dream home.
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