Saving vs. investing, explained
Quick insights
- Saving and investing can be ways to grow your wealth but may serve different objectives and time frames.
- Savings accounts offer stability and easy access, while certain investment products may provide higher potential returns but more risk.
- Combining saving and investing may help meet both short-term needs and long-term financial goals.
Saving vs. investing: Both aim to grow your money over time but in different uses or time frames. Understanding the difference between saving and investing is key to making more informed financial decisions and learning how to potentially use them together. Let’s look at how each method works and their pros and cons.
What is a savings account?
A savings account is a bank account designed to encourage long-term saving. They may accrue interest over time, paying a percentage of their balance at regular intervals, and typically limit withdrawals and transfers. Generally, many individuals consider savings accounts to be less volatile compared to investment products.
There are various types of savings accounts, each one suited for different purposes. Certificate-of-deposit (CD) accounts might be useful for those seeking stable, predictable returns and who don’t mind sacrificing accessibility. A high-yield savings account is a savings account that funds more regular expenses through checking transfers and may provide higher returns than traditional savings accounts. As an account offered by a bank, the deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable limits and there’s little to no risk in depositing your money in a savings account.
What does it mean to invest?
Depending on your investment objective, investing is buying assets with the expectation that their value will appreciate with time or they can provide a steady stream of income over time. Investment products can take many forms, such as stocks, bonds, mutual funds, exchange-traded funds and more. Each investment vehicle offers its own mix of potential risk and reward. Stocks, for example, are considered more volatile than bonds because their value tracks the success of a single company. Some other investments like mutual funds or exchange traded funds invest in a basket of different securities, which may provide diversification in a single investment and may be less volatile than a single stock or bond since the performance of the underlying portfolio can reduce the volatility. Because of the different types of investment options available, it’s important to understand your risk tolerance, investment objectives and time horizon before you invest. Because of market volatility, there is risk involved in investing, including losing your principal.
The difference between saving and investing
Savings accounts generally emphasize stability and are income vehicles, whereas investments may aim for higher returns and can either provide income, growth or some of each. For cash you need in the short term or for storing emergency funds, savings accounts may be an option. Investment accounts are something to consider when looking for long-term growth and wealth preservation. Let’s look deeper at the difference between saving and investing and some pros and cons for each.
Pros and cons of savings accounts
Pros:
- FDIC insurance: Savings accounts at FDIC-insured banks are insured up to the maximum amount allowed by law.
- Stability: The value of the funds in your savings account are not subject to market loss and will not drop in value.
Cons:
- Inflation: Inflation may erode the purchasing power of your money over time.
- Limited growth potential: Savings accounts generally offer lower growth potential than many investments, limiting their capacity to build wealth.
Pros and cons of investing
Pros:
- Higher potential returns: Certain products have the potential to generate higher returns compared to traditional savings. Positive performance however is not guaranteed.
- Securities Investor Protection Corporation (SIPC) insurance: This protects investors by replacing a certain amount of missing cash and securities if their brokerage firm fails, though it does not cover normal market losses.
- Wide product offering: Investment products span a wide spectrum of risk and reward, ranging from conservative bonds for steady income to growth-oriented stocks and alternative assets.
- Purchasing power: Some investments tend to outpace inflation. This makes them worth considering for possibly maintaining or potentially increasing the purchasing power of your money.
Cons:
- Risk of loss: Investing comes with a risk of losing some or all the invested funds, particularly in more volatile markets.
- Complexity: Making an informed investment generally requires knowledge and understanding of financial markets and the specific investment vehicles, which is challenging for some individuals.
Should I save or invest?
To determine whether you should save or invest, it’s generally recommended to first determine your financial goals. Understanding what you want from your money, and when, may help provide insight into your time periods and risk tolerance. This may help highlight the saving and investment options that might be suitable to achieve your goals.
When to save
Why put money in a savings account? You might choose to use one for a few reasons:
- You’re building an emergency fund: Before investing, it may be wise to establish an emergency fund with three to six months' worth of living expenses. This may be helpful for not only supporting yourself during periods of low or no income, but also for protecting existing investments from liquidation in the case of financial hardship.
- Your risk tolerance is low: Savings accounts are generally considered low-risk, though low reward. If the prospect of potentially losing some of your funds outweighs the chance for higher rewards, saving might be a safer option.
- You need cash available: Because your funds remain relatively accessible, savings accounts could be useful when stable cash flow is desired.
- You have short-term goals: Savings accounts might also be useful for shorter time periods where inflation is less likely to prevent your progress, and investments have less time to mature.
When to invest
Why would you invest your money? Typically, investing aims for long-term growth and the pursuit of higher returns than saving. Depending on your objective, time horizon and risk tolerance, if you’re aiming for long-term growth, here are a few things to consider:
- Risk tolerance: Investing long-term may offer higher growth potential; however, there is volatility with the value of the asset along the way. Different investments have different levels of risk. For example, stocks are generally considered riskier than bonds.
- You want to diversify: There are opportunities to spread your money across different types of investments and multiple markets. Not putting your eggs all in one basket leaves your investments’ value less subject to the fluctuations of singular assets. Diversification and asset allocation does not guarantee a profit or protect against a loss.
- Objectives: For major milestones with longer time periods, investing may offer better growth potential than saving. There are also many different investment types catering to specific goals, such as retirement or paying for education needs.
Combining saving and investing
The question of “Should I save or invest?” can sometimes be misleading; saving and investing are often used together to pursue a variety of different goals. Saving is often used to help meet immediate needs and maintain financial stability. Investing is generally considered a potential way to grow funds for future more long-term goals.
In summary
Saving vs. investing is a decision many individuals make in their financial journey. By understanding their different mechanisms, advantages and limitations, you may be better equipped to align your financial strategy with your personal goals. Whether you’re seeking the stability of savings or the potential rewards of investing, knowledge is the key to more informed decisions.
