While investing and saving are both crucial ideas for laying a strong financial foundation, they are not the same thing. Both can help you build a more secure financial future, but consumers need to understand the distinctions between the two and when each is preferable.
The main distinction between saving and investing is the amount of risk accepted. Saving often leads in a lesser return but with almost no risk. Investing, on the other hand, gives you the possibility to make a bigger return while also exposing you to the danger of loss.
 |
| Investing or Saving Money: Which is better? |
When I first started working with clients, one of them was a 38-year-old single man who earned $100,000 annually. She had $9,000 in savings and $112,000 in her [401(k)] retirement account, with a 6% monthly payment and a 4% corporate match. She had just paid off her college loans, so she got an "extra" $800 at each month's end.
To Improve Your Strategy, Set Goals
We determined the solution to her inquiry by writing out her financial goals, followed by the savings, investment, and interest necessary to fulfill them. She would need to set aside and invest the following each month in order to achieve her objectives:
- Monthly payment of $250 for her emergency fund
- Every month, she saves $250 for her journey.
Extra retirement funds of $525 per month, presuming:
- Pre-retirement annual average growth rate = 8%.
- Post-retirement annual average growth rate = 6%.
- 3% Inflation.
- At 67, the full retirement age, $2,630 worth of Social Security benefits can be accessed.
We handled the conserve vs invest topic for this customer by assessing what she had today and estimating what she could contribute in the future. What would accomplish her objectives while meeting her deadlines?
My client had a decision to make since the overall monthly dollar amount necessary to fulfill her financial goals was larger than the $800 per month she presently had available. Now that she could see the necessary monthly investment to achieve each one, would she want to preserve her $800 for travel, increase her cash reserve, or invest more for her retirement?
Because of this, there isn't a single response to the save vs. invest dilemma. What you require, when you require it, and how much you can afford to contribute all play a role. As a general rule, I tell my customers to look at a few important variables to assist them to decide whether they should save or invest their money based on their unique situation.
Short-Term versus Long-Term
You would often invest your money for long-term financial goals such as retirement because you have a longer time frame to recoup from stock market changes. However, if your financial aim is short-term say, five years or less, as it normally is for vacation goals investing your money is usually not a good idea.
In such instances, because you won't have much time to recover from a significant slump, you're better off putting it in a high-yield savings account. Of course, your individual risk tolerance and financial situation will also play a role in this.
Because of this, I recommended to this client that she continue to invest for her long-term retirement plan while also setting aside a percentage of her additional income for short-term goals and a cash reserve.
Pros and Cons of Saving
Pros:
- Because your money is liquid, you can access it anytime you choose.
- Market volatility won't affect you.
Cons:
- Gains from the market and possibly significant amounts of compound interest will be lost to you.
Pros and Cons of Investing
Pros:
- Compounding interest, which grows your money, is possible with a longer time horizon.
Cons:
- Investments may lose value because markets are fundamentally risky.
- If you remove the money too quickly, you may suffer a penalty.
To assist others in making this choice depending on their individual requirements, I quickly devised a checklist. However, this is a fantastic place to start. Of course, it's always ideal to work with your own certified financial planner who can assist you with your entire financial strategy and ensure that you are making the right choices for yourself:
Although it won't cover everything, this checklist is a fantastic place to begin when trying to picture the future you desire, plan the path to get there and estimate the costs. As usual, it's a good idea to consult with your personal financial adviser about your present financial situation, future financial objectives, and the best route to get there.
Checklist: Save vs. Invest
- Are you in possession of a sufficient financial reserve to cover three to six months' worth of fixed costs? If not, start saving now.
- Are you planning any additional short-term ambitions that need immediate access to funds (such as trip plans)? If yes, begin saving.
- Achieving your retirement objectives by the age you want to is on track? Start investing if you haven't already.
- Are you aware of the dangers associated with investing this money for a long-term objective such as retirement? You may not be able to use it until age without paying taxes and penalties, and you will incur volatility risk, among other things.
- Are you willing to wait to access your money in order to benefit from compounding? You may wish to start investing if that is the case.
- How much money do you currently save and invest each month? Do you feel comfortable with this split? Where do you feel that you need to improve?
Frequently Asked Questions About Investing And Saving
What Should I Save in Savings?
People's perspectives differ. To be cautious, most experts recommend keeping a financial buffer of three to six months' worth of spending on hand. Today may be a sunny day. However, there is always the possibility that you will lose your work or be faced with a large unexpected expenditure.
Should You Invest or Save Money?
Your risk tolerance, your financial needs, and the time frame in which you need to access the money all play a role in this. Investing has the potential to produce substantially larger returns than savings accounts, but this advantage comes with risk, particularly over shorter time horizons.
You would probably be better off keeping the money in a savings account if you are saving for a short-term objective and will need to withdraw the money soon. Longer-term aims, on the other hand, will often yield more satisfying rewards from investment.
How Is Investing More Dangerous Than Saving?
The Federal Deposit Insurance Corporation (FDIC) insures most bank and thrift savings account for up to $250,000, which means you won't be out of pocket if the institution holding the funds fails. This is not how investing works. There is usually no insurance when you invest money. In essence, you are trading the possibility that you could not get everything back for a bigger reward.
Naturally, not all investments are the same. Some have more potential rewards and risks, while others are far less volatile, with a reduced probability of losing money and a lesser possible payoff. In general, the greater the risk, the greater the potential gain.
