Savings and investing are both important, but they’re not the same thing. All of us should actively be doing both, but sometimes it’s hard to differentiate between the two because they seem similar.
For consumers, the main difference has to do with what’s known in investing as time horizon. Think of it like this: If the money needs to be there in the short-term, savings is probably more appropriate term. If it’s money earmarked for longer-term needs, such as retirement, then let’s call it investing. Here’s more on this.
What is saving?
Saving is the act of putting away money for a future expense or need. It usually is money that will potentially be used or at least be available to be used in the short to medium-term. Though it could be used to save for a long-term goal as well. When money is being saved, it is generally going to be in a low-risk account. With this low-risk account, you should get the highest annual percentage yield (APY) savings account that aligns with the minimum balance requirement in that account.
What is investing?
Investing could be a short or long-term event. Generally, investments are stocks, mutual funds or exchange-traded funds. But in most cases it should be a long-term activity as opposed to buying and selling stock in a very short time span, like daytraders. Investing is a long-term activity, because it often is associated with retirement or other longer-term life goal like buying a home. Investing also may involve the risk of loss – since some investments may have volatility or investment risks.
How are saving and investment similar?
They are similar because they accumulate money. Savings accounts will help you accumulate money with compound interest. Your account balance will grow at the rate stated in the APY.
“I think first and foremost, both involve putting money away for future reasons,” says Chris Hogan, financial expert with Ramsey Solutions and author of Retire Inspired.
Investing is money that you’re planning to leave alone, “to allow it to grow for your dreams and your future, later,” Hogan says.
Even if you have some debt, Hogan says try and start off by saving $1,000 in an emergency fund. That will give you at least a little cushion in case some type of unforeseen event happens. After debt is paid off, then Hogan says it’s time to fund your emergency savings account so that it contains three to six months of living expenses in it.
“So if you have an illness, a job loss or whatever, you don’t have to resort back to debt – you’ve got money you’ve intentionally set aside to be a cushion between you and life,” Hogan says.
How are savings and investing different?
When you think of saving, think of bank products such as savings accounts, money markets and CDs. And when you think of investing, think of stocks, ETFs and mutual funds, says Dan Keady, CFP, chief financial planning strategist at TIAA.
Also, when you think of saving, think stability and guaranteed returns. Investments are usually going to be associated with fluctuation, volatility and risk of losing principal.
For the most part, investments can gain or lose money and a savings account will only gain value. Generally, fees – such as maintenance fees or Regulation D violation fees when more than six certain transactions are made out of a savings account – are the only way a bank savings account at a Federal Deposit Insurance Corp. (FDIC) bank can lose value.
Investments, such as stocks or mutual funds, aren’t insured against loss. Savings and investing are different. Real-life examples are the best way to illustrate this, Keady says. For example, paying your child’s college tuition in a few months should be in savings – a savings account, money market account or a short-term CD or a CD that’s about to mature when it’s needed.
“When you use the word just saving and investing, people, really 90-some percent of people, think it’s exactly the same thing,” Keady says.
Money that has to be available at a certain time, needs to be in safe account – such as a savings account, money market account or a CD.
“Otherwise people will think, ‘Well, you know, I have a year and I’m buying a house or something, maybe I should invest in the stock market,” Keady says. “That’s really gambling at that point, as opposed to investing. Investing is where you have longer-term goals and you can hopefully take advantage of the general upward trends in stock prices over time.”
An easy way to differentiate the two is by looking at the time horizon – near-term goals are when you should save at a bank and investing is for long-term goals, Keady says.
Investing vs. Saving
Here are some pros of investing:
Save money now to live later on
When it comes to investing, you’re trying to grow your money for the future.
“With investing the world makes it more complicated than it really should be,” Hogan says. “All you’re doing is saving money for your dreams and you’re putting money away so you have it later. If we don’t invest, we won’t have anything to spend later on.”
Investing will help you keep up with inflation
Investing is your best defense against losing purchasing power. Currently, the inflation rate that the Federal Reserve uses is at 2.0 percent. If your return is below the inflation rate, you’re losing purchasing power over time.
Investing can help you save for retirement
Over time, your investments can help your money grow so that you have enough accumulated during retirement. Usually, the more time you have, the better it is for your account to grow.
Here are some cons of investing:
Investing may involve risk
Investments are usually not guaranteed. They generally involve risk of principal and or you could potentially lose all of your money in an investment. But at the same time, investments are ways to grow your portfolio at a rate of return not seen in savings accounts, money market accounts and in CDs.
Investing can be complex
If you’re not a professional, there’s the risk that you might not understand all the components – and potential risks – of an investment. Investing in single stocks isn’t recommended, Hogan says.
“So if someone’s beginning with investing, I would encourage them to really look at growth-stock mutual funds as a great starter way to get your foot in,” Hogan says. “And really start to understand what’s going on and how money can grow.”
Investing may have fees
There may be fees associated with investments. These include expense ratios, commissions for trading or a commission on money that’s being managed by a brokerage. It could also be a fee paid to your financial adviser.
Here are some pros to saving:
Savings is secure
Safety is the main benefit to saving. As long as the savings account is with an FDIC bank, and meets the FDIC requirements, your money is protected. This gives you the confidence to know that your money will be there when you need it.
Emergency funds are vital
Savings is necessary as your first defense when an unexpected event happens. When you become a saver, you will no longer be relying on debt if an emergency occurs, Hogan says.
“We don’t want to rely on the credit card,” Hogan says. “We don’t want to call friends and family when we get in ourselves in bind.”
The power of compounding
Compound interest is a feature of savings accounts, money market accounts and CDs. This helps both your principal, current interest and previous interest grow at a faster pace – depending on the frequency of the compounding.
“You have two best friends of your money,” Hogan says. “I say time and compound interest. Those two things working together can make a couple hundred dollars a month start to turn into hundreds of thousands down the road.”
Here are some cons to saving:
Lower potential earnings
Generally, savings accounts may provide a lower rate of return than investments, which have potential risks.
It may be tough to stay ahead of long-term inflation
Savings accounts may not be able to keep up with long-term inflation as it rises. While this may not be the case in the long-term future, currently the APYs on the very top savings accounts and CDs are earning more than the current inflation rate.
Too much in savings should be avoided
Try to allot the right amount of short to middle-term money in a savings account. If you have too much of your long-term savings in a savings account, you may lose out on potential investment opportunities in the stock market.
Who should save vs. who should invest?
Everybody should be saving – or trying to save – no matter what point you’re at in your life. Investing gets a little trickier, because as you get older your risk tolerance changes. This means, generally, the older you are the more conservative your investments will probably be. The main reason for this is because when you’re older, you’re closer to that retirement finish line – so you’re ready to use the investments that you accumulated to potentially supplement your retirement income. Also, when you’re younger, if you’re in a higher-risk investment – and suffer a loss – you have time on your side to rebuild and recover. Time is one of your greatest assets as an investor.
A investor should be able to handle both the good times and the bad times. If you can’t, investing might not be for you.
“So I think one of the best things people can do is prepare and ask themselves, ‘If I’m down can I deal with that? And how can I make sure that I don’t simply go into the cycle, which some people do, buy high because everything sounds great – you know you listen to the news, everything’s great,” Keady says. “And then when everything sounds bad, sell low. That cycle, which can be so difficult for people to break out of.”
What would saving be better for?
Saving is better for that money that you need to be there for you during the short to middle-range times. Your emergency fund is a form of savings – investments should not be your emergency fund, if possible. And this is the first place you should turn to for money in a financial emergency. Generally, you wouldn’t want to have to touch your investments in an emergency because that could cost you potential accumulation if the money isn’t actively invested.
What would investing be better for?
Investing is better for longer-term money – money you are trying to grow more aggressively. Depending on your risk tolerance, investing in the stock market, exchange-traded funds or mutual funds may be an option for someone looking to invest. Also, taking advantage of an employer-sponsored account – such as a 401(k) – is a way that investing may provide higher, longer-term returns.