Saving vs. Investing: What's the Difference?
In the world of personal finance, the terms "saving" and "investing" are often used interchangeably to describe building wealth, despite some crucial differences between the two.
Although there are similarities between saving and investing, it can be valuable to understand how they differ and how each can play a role in helping someone achieve their financial goals.
Saving Happens First
When looking at saving and investing, saving usually happens first. There are many different reasons why people decide to save money, but saving is often used to prepare for any sudden emergencies, such as an unforeseen medical expense or job loss, or to meet shorter-term financial goals, such as buying a new car or getting married.
Typically, an important first step when saving is to build an emergency fund. This emergency fund is what stands between someone and the inevitable ups and downs of life. As Murphy's Law states, "Anything that can go wrong will go wrong," which is why it can be critical to have an emergency fund in place. The amount needed will vary depending on the specific situation, but most experts recommend saving somewhere between three to six months' worth of living expenses.
Saving Is Secure and Liquid
One of the defining aspects of saving is that individuals typically hold their savings in a very liquid or easily accessible place, such as a savings account at a financial institution. Because your funds are held in an account, the money is generally considered very safe and accessible.
For example, in the United States, the FDIC and NCUA insure most banks and credit unions, which means savers are covered against losses at $250,000 per account. Savers outside of the U.S. can check the laws in their country to understand if they're automatically covered against losses.
Additionally, it's common for savings to be in a very conservative position since the primary goal with saving is keeping your money safe rather than creating a return. Some may choose to hold their savings in cash, but others might also choose to keep their savings in short-term bonds or other low-risk assets.
Investing Puts Your Money to Work
People often choose to invest because, unlike with standard savings accounts, investing can help a person grow their money by generating a higher rate of return. When it comes to longer-term financial goals such as retirement or funding a child's future education, investing can be a helpful tool.
One of the most important things to understand about investing is that investors are typically rewarded for staying invested for long periods. That being said, part of the trade-off with investing is that an individual's investments could be in a downturn in the short term. That is why many match longer-term goals with investing and shorter-term goals with savings.
Investing Comes With Risks
A major difference between saving and investing is the types of assets that are used. While savers focus on low-risk liquid assets like cash and cash-like securities, investors typically aim for higher-risk asset classes such as stocks, real estate, and bonds. In the United States, investors are able to use a variety of brokerage accounts to purchase their investments, and some even come with favorable tax advantages when used for retirement savings.
The rate of return that investors receive is closely tied to the amount of risk they are willing to take—generally, the riskier the investment, the higher the potential rate of return. There are many different ways to invest with various investment accounts and asset classes depending on an individual's investment goals.
Should I Save or Invest?
When deciding between saving and investing to reach your financial goals, it's essential to look at your own unique circumstances.
Individuals can start by looking at their specific goals to determine whether saving or investing is the best move for them. For example, if an individual hasn't started an emergency fund yet, they may prioritize saving over investing to build a stronger financial position for themselves. But if they already have an emergency fund and want to add to their savings for longer-term goals, investing can be a great way to generate higher returns to help achieve those goals.
After looking at your goals, the next move is to think about risk tolerance. Some people are comfortable taking on some risk in exchange for higher rates of return, making investing a solid option for them. Others may be more focused on minimizing risk and are okay with lower returns, making saving the better fit.
When it comes to investing, investors must do their research and consider all the risks involved. The world of investing can be well worth the effort—especially over long periods—but it can also be very complex. As with any important financial decision, assessing your needs can help you decide on whether investing or saving is the right choice for you.
Conclusion
Overall, the great thing about saving and investing is that they can work together to help you reach your financial goals. But because there is no one-size-fits-all approach to achieving goals, it's essential to understand the differences between saving and investing so you can choose the best method for your situation.
All investments carry some level of risk and may not be suitable for all investors. Before deciding on any investment, you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment, and therefore, you should not invest money that you cannot afford to lose. Seek advice from an independent financial advisor if you have any questions or doubts. Our content is for informational purposes only and is not intended as legal, tax, or financial advice.