Why Investing is Better Than Saving?
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By definition, saving means putting away money for later use in a safe place, like in a bank account while investing means taking some risk and buying assets that will ideally increase in value, and provide you with more money than you put in, over the long term.
It’s up to you to decide whether saving or investing is the better choice to reach your financial goals. Whether you’ve been working on your finances for years or you’re just getting started, it can be difficult to know when you should be saving and when you should be investing.
Saving is the safer route if you don’t have an emergency fund. You should also prioritize saving over investing if you’ll need the cash in the near future. You should invest what you can if you’re eligible for a 401(k) match.
The dollar amount in your bank account won’t decrease unless you withdraw funds, but interest rates on savings accounts are often lower than the rate of inflation and don’t allow your money to grow very quickly.
This means your savings could lose purchasing power over time. You may be tempted to want to invest to receive higher returns and beat inflation. Unfortunately, the value of your investments won’t always go up. In certain cases, investments can also become completely worthless.
There’s a difference between saving and investing: It is widely recommended to save at least three to six months of living expenses.
Is saving better than investing?
It’s better to save rather than invest if you don’t have an emergency fund or if you’ll need the money within the next few years.
How much should you keep in savings vs. investments?
You should prioritize saving enough cash to cover three to six months of living expenses. You could also consider investing money once you have at least $500 in emergency savings.
Once you’ve paid off high-interest debt, topped-up your emergency fund and don’t anticipate needing a lot of money in the next few years, you may also consider investing more money.
When to save and when to invest
Every person’s situation is unique and you should base your decision based on your particular situation. If you’re not sure what to do, consult a financial advisor that can help you decide.
There is a general framework that may work for you including:
Build your retirement account
Get your retirement account’s matching contribution. If your workplace matches the money you put into your 401(k) or other retirement account, it’s free money you should take advantage of.
Build your emergency fund
Next, build a small. A small emergency fund of $500 to $1,500 emergency fund in a savings account can help you stay out of debt for good rather than putting small emergencies on credit cards. You can rely on your emergency fund to cover minor emergencies.
Paying off debt
After building your emergency fund, consider paying off high interest debt with rates of 10% and higher.
Max out your retirement accounts
It’s up to you to choose an IRA or a Roth IRA, but either way you should invest in a tax advantaged account. Max out your workplace retirement account because you have more options for where to invest your IRA.
You can choose where to hold your IRA and what it invests in. A workplace retirement account is limited to the options your specific plan offers.
Factor in one time goals
You’ll also need to save for major one time goals, such as buying a home or buying a car with cash. It’s up to you where to fit these goals and balance them with your retirement investing. This is to make sure you reach both goals within the timelines you’re most comfortable with.
You’ll have to decide whether to save or invest to reach your set goals depending on your flexibility and time frame of each goal.
If you must reach a goal by a certain date, you’re better off saving rather than investing. If you’re a bit more flexible about when to reach a goal, investing may be an option to consider.
You could receive higher returns on your investment, but a bad year in the markets could also substantially delay when you reach your goal.
Medium-term goals
Medium-term goals are things you plan to do within the next five to ten years. Cash deposits might sometimes be the best option. But it depends on how much risk you’re willing to take with the money to achieve a greater return on your investment.
For example, if you’re planning to purchase a property in 7 years and you know you’ll need your savings as a deposit and don’t want to risk the money, it might be safer to put the money into a savings account.
However, your savings will still be at risk from inflation so the buying power of your money may be reduced. If your needs are more flexible, you might want to consider investing your money and achieve a greater return on your investment than would be possible by saving alone.
Long-term goals
Long-term goals include a retirement fund. For long-term goals, you may want to consider investing. This is because inflation can seriously affect the value of cash savings over the medium and long-term.
Stock-market based investments tend to do much better than cash over the long-term, providing an opportunity for greater returns on money invested over time. You can lower the level of risk you take when you invest by diversification which means, spreading your money across different types of investments.
How to decide whether to save or invest
Deciding whether to save or invest for a particular goal can be quite difficult. You can save the money you absolutely need and invest the money that would be nice but isn’t necessary to meet your base goal. The key is being able to delay your goal.
Another option is to invest toward the beginning of a long-term goal and slowly switch to saving as your goal gets closer. This helps you avoid a sudden drop in your investment values that could delay your goal.
If investments are down at the time when you originally planned to reach your goal, delaying by a few years could result in your investments returning back to a much higher value.
You can also mix saving and investing. Ultimately, it’s up to you to decide whether saving or investing is the better choice to reach your financial goals. How and whether you invest, save, or do both will more than likely continue to change over the years as your priorities and goals also change.
Choosing whether savings or investing is right for you depends on:
How much cash you have available
Your age
Your personal circumstances.
You also need to consider your goals more specifically if they’re long, short, or medium term:
Short-term goals
Short-term goals are things you plan to do within the next five years. The general rule is to save into cash deposits, such as bank accounts.The stock market is unpredictable in the short-term, and if you invest for less than five years you might make a loss.
If you have short-term goals, save first. If you absolutely need the money by a certain date, save rather than invest. With savings, there is no risk of your cash balance decreasing. On the other hand, investments can decrease the value of your money.
What’s the difference between saving and investing?
If you’re still not sure whether to start investing, or if you should focus on saving, the answer may depend on your goals, risk tolerance, and current financial situation.
Saving
Saving is putting money aside gradually, usually into a bank account. People save for a particular goal, or any emergencies that might come up.
You usually save up to pay for something specific, such as a holiday, a deposit on a home, or to cover any emergencies that might crop up. Saving often means putting your money into cash products, such as a savings account in a bank, building society, or credit union.
When to save
Financial advisors say that having a financial cushion for emergencies should always be your first priority. Saving your cash is a smart first move if:
You don’t have emergency savings.
Set aside at least one month of living expenses. Even $500 is a good buffer against an emergency. The general rule is to have at least three months’ worth of living expenses saved up in an instant access savings account.
This should include rent, food, school fees and any other essential outgoings. Your emergency fund means you have some financial security if something goes wrong.
You need the cash within five years.
Short-term savings should stay in a savings account, where returns are guaranteed, and not invested in the stock market.
Saving for the short term.
This is usually good for smaller, shorter-term goals in the near future like saving for a large purchase or for an emergency.
Ready access to cash.
A savings account gives you access to cash when you need it.
Involves minimal risk.
Your funds are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, per FDIC-insured bank, per ownership category.
Earn interest.
You can earn interest by putting money in a savings account. Savings accounts earn a lower return than investments.
Keep saving
It’s a good idea to save a bit more if you can afford it. Set yourself savings goals and put away enough to buy what you want. This could be a house deposit, a wedding, or a trip.
When you shouldn’t save?
The only time you shouldn’t save or invest is if you need to get your debts under control.
How to pick a good savings account
Almost every financial institution offers a savings account. Look for one that has:
FDIC insurance.
This insurance guarantees you won’t lose money if your bank fails. It covers up to $250,000 per depositor, bank and ownership category. It's worth checking when joining a new, startup bank.
A high annual percentage yield.
Many banks pay 0.01% APY on deposits. But online banks, which offer FDIC insurance, often have rates around 0.40% or 0.50%. Securing a high APY matters.
No monthly fee.
Some banks waive it if you have a large enough balance or meet certain criteria. Others won’t charge a monthly fee no matter what. Find a savings account that’s free for you.
When it comes to your savings, earning interest should be the highest priority. Set up automatic transfers from your checking account so you can contribute effortlessly.
Certificates of Deposit
Certificates of deposit (CDs) allows you to earn a higher interest rate on your money. Usually, you promise a bank that you won’t withdraw the money for the full term of the CD in exchange for earning a higher interest rate.
You may be able to withdraw the money early depending on the terms of the CD but you’ll have to pay an interest penalty. Some CDs offer penalty free withdrawals, but they usually offer lower interest rates.
Savings accounts
A savings account is a bank account that allows you to set money aside and earn interest in the process. Some savings accounts usually pay a lower interest rate while others offer higher interest rates that can help grow your money.
Online savings accounts offer higher interest rates than other banks. And don’t rule out checking accounts.
Money Market accounts
A money market account is like a savings account that earns interest. This type of account may also allow you to write checks, too. Money market accounts sometimes have higher minimum balance requirements.
Banks may also restrict the number of withdrawals you can make on these accounts and you may have to pay fees too.
Money market accounts offer higher interest rates than normal savings accounts, but that isn’t always true.
Savings bonds
Savings bonds are issued by the government. You can buy a savings bond and earn interest over time. However, interest rates on savings bonds aren’t always great.
Savings bonds usually work out best if you hold them to full maturity, which can take up to 20 years. If you redeem them early, you may have to pay an interest penalty.
Pros of saving
There are benefits to saving money.
The money you save in a savings account won’t decrease over time as long as you don’t make withdrawals. This is important because some goals are critical regardless of whether investment prices are up or down.
Saving also allows you to reach your goal on time as long as you save the correct amount of money each month. Take the total you need to save and divide it by the number of months until you need to reach your goal to find the amount you need to save each month.
Cons of savings
Saving does have some downsides.
Due to inflation, the money you save will decrease in value each year. If you earn interest, that interest may partially offset the negative effect of inflation but the rates rarely keep up with the rate of inflation.
Saving also means you’ll have to set aside more money each month. If you’re only earning 1% interest in a savings account but could earn 8% return investing, you’ll have to make up for that 7% difference by putting more money in your savings account to reach your goal at the same time.
Consider investing more money if:
You have a topped-up emergency fund or you’re making good progress.
Three to six months of living expenses is just a starting place; save more if you’re self-employed or are in a single-income household.
You’ve paid off high-interest debt.
Student loans and mortgages often have low interest rates, and you can feel comfortable paying the minimums in most cases. But when it comes to credit card balances and other high-rate debt, think about the return. It does not make sense to pay 20% a year to carry a credit card balance of $5,000 and then invest $5,000 and get a 7% return.
You have long-term goals that will require a lot of cash.
These are expenses that won’t be due for at least five years. Retirement is a big one, or a college fund for younger kids.
Investing
Investing is using some of your money with the aim of making it grow by buying assets that might increase in value over time. For example, you may invest in stocks, property, or shares in a fund.
While the gains from investing can be much higher than saving, the value of investments can go down as well as up. You can also start to think about investing your money if you don’t need the money in the next five years.
When to invest
Ideally, you should consider investing money for the long term mostly for your retirement. But sometimes investing has to take a back seat, with one notable exception:
You’re eligible for a 401(k) match.
If your employer offers a 401(k) or other workplace retirement savings plan, it might also match a percentage of your contributions up to 4% or 6% of your salary. This is free money, but the only way to get it is to sign up and save enough to get the full match.
Why Invest?
Having a savings account isn’t enough
Saving money is important, but smart savers start by building sufficient emergency savings within a savings account or through investment in a money market account. After having three to six months of easy-to-access savings, investing in the financial markets may offer many potential advantages.
Investing used for long-term goals.
Investing may help you reach your long-term goals, like paying for a child’s education or planning for your retirement.
Longer wait to access invested funds.
When you invest money, it can take a few more days to access the money compared to a normal savings account.
Always involves risk.
Investing usually does not guarantee a return, and it is possible you may lose some or all of the money you have invested.
Earnings potential.
Investments usually have the potential for much higher returns than a savings account.
Why investing matters
Investing is an effective way to put your money to work and potentially build wealth. Smart investing may grow your money to outpace inflation and increase in value. The greater growth potential of investing is mainly as a result of the power of compounding and the risk-return tradeoff.
The power of compounding
Compounding occurs when your investments generate earnings from previous earnings. An investment generates earnings or dividends which are then reinvested. These earnings or dividends then generate their own earnings.
If you invest in a dividend-paying, for example, you may want to consider taking advantage of the power of compounding by choosing to reinvest the dividends.
To increase the potential benefits of compounding, start investing as soon as possible and automatically reinvest your dividends and other distributions.
The risk-return tradeoff
Risk is an investment’s chance of producing a lower-than-expected return or even losing value.
Return is the amount of money you earn on the assets you’ve invested, or the investment’s overall increase in value.
Different investments offer varying levels of potential return and market risk. Investing in stocks, for example, has the potential to provide higher returns. In contrast, investing in a money market or a savings account likely won’t offer the same return potential but is considered less risky than investing in stocks.
The amount of risk you carry depends on your appetite or tolerance for risk. Only you can decide how much risk you’re willing to take for the potential of higher returns.
If you’re seeking to outpace inflation, taking on some risk may be necessary. An increase in risk may provide more potential for your money to grow.
Are you ready to invest?
Before choosing to invest your money, remember that there’s always the risk that you could lose money. When investing, it’s a good idea to consider if you would benefit from professional advice from a regulated independent financial adviser.
How do you know when you should stick to the much safer route and save or risk more to earn bigger returns and invest? You may want to consider starting your investment strategy after you’ve:
Emergency savings.
Savings should come first. Before investing, make sure you have a separate low-risk, low-return savings account you can use to cover expenses during an unforeseen event.
Paid off high-interest debt.
Paying off high-interest debt in full will reduce the total amount you owe faster and free up money to put toward savings or investing.
Maxed out your 401(k) and IRA.
If your long-term goals include a comfortable retirement and you’re already contributing the maximum amount to your retirement accounts, it may be an appropriate time to explore additional investment.
How to pick a good brokerage account
First, decide how hands-on you want to be.
For beginning investors, robo-advisors services that use algorithms to manage your investments based on your risk tolerance, goals and other factors may be most suitable.
These usually offer “nice diversification, low costs and rebalancing. This means you won’t pay much to have a variety of investments, and the algorithm will make sure they keep the right asset allocation mix.
If you’d prefer a traditional brokerage, many offer similar services that are good for beginners. Find a company where you can open an account for zero fees, and where you can find low-cost index funds that you can add to each month for no fees.
The best banks, credit unions and brokerages make things easy. Once you’ve found the right financial institution and set up automatic transfers, your money will grow without you needing to lift a finger.
Investing tools
Robo-advisors
Robo-advisors, such as Betterment, Personal Capital, and Wealthfront, allow you to invest with the help of an automated advisor. Rather than dealing with a person, the software will build a portfolio for you based on your risk tolerance, goals and other factors.
Because you are not dealing with a traditional advisor, the fees for these services are usually much lower. However, they still cost more than doing it yourself.
If you don’t feel comfortable investing on your own, a robo-advisor can be a great compromise between solo investing and a full-fledged, expensive, investment advisor.
You can build your own custom investment portfolio by selecting ETFs in categories like socially responsible investments (SRI), technology, health care, and clean energy.
After you select your investments, a robo-advisor does the rest for you. From automatically rebalancing your portfolio, to reinvesting your dividends, and even using tax-loss harvesting to minimize the taxes you pay as you invest.
Investing apps
Investing apps like Stash and Acorns make it easy to start investing from your phone. Each app has its own unique selling points.
Brokerage accounts
Traditional brokerage accounts are essentially accounts you can use to purchase investments. They usually offer the greatest flexibility when it comes to investing.
Each brokerage will have their own features and fee schedules. Make sure to shop around to find the best brokerage account for your situation.
How to choose the right investments
Building wealth through investments can start at any age and at any income level. The key is to choose the right investments for you based on the following considerations:
Your timeline.
Money meant for short-term needs should be easily accessible and put in a safe and stable investment. For long-term goals, you have more leeway to invest in more volatile assets.
Your risk tolerance.
The more risk you’re willing to take by exposing your money to the short-term swings of the stock market, the higher the long-term potential payoff. Spread your money across different types of investments to help smooth out your investment returns.
How much money you have.
Some investments have minimum balance or initial investment requirements. But there are ways and providers that can accommodate most investment budgets if you know where to look.
How much help you need.
DIY investors can access many investments by opening a brokerage account. If you’re not sure which investments are best for your situation, you can hire a low-cost, automated service such as a robo-advisor to build an investment portfolio for you.
Cons of investing
Investing isn’t always a good thing. Investment prices could go down right before you need the money which could leave you in a financial mess.
If this happens, you will have to either settle for an option that doesn’t cost as much, delay your goals until you can save more money, or delay your goals until your investments increase in value.
Pros of investing
Investing gives your money the potential to grow faster than it could in a savings account. If you have a long time until you need to meet your goal, your returns will compound.
This means in addition to a higher rate of return on investments, your investment earnings will also earn money over time. The benefit of higher compounding returns is you won’t have to invest as much each month as you would need to save each month to reach your ultimate goals.
When is it best to stop Investing and put more money into savings?
You'll often hear that investing your money is a great way to grow it into a larger sum over time. And that's true.
But there may come a point when it makes sense to stop investing and focus more on pumping up your savings. Here are three reasons why.
Your emergency fund isn't robust enough
Your emergency fund should have enough money to cover three to six months of essential bills. But if those circumstances have changed, it could make sense to save more for emergencies. And to do that, you may need to hold off on putting money into an investment account for a period of time.
You've recently dipped into your emergency fund
If you recently had to take an emergency fund withdrawal for a surprise expense, that's fine. At the same time, though, you may want to make an effort to replenish the funds you removed from your savings. That could mean diverting some money away from your brokerage account and putting it into the bank instead.
You're saving money away for a specific short-term goal
Your emergency fund may not be the only savings you have. If you're trying to save up for a home, a car, or a vacation, then that money should be in your bank account, because if you invest it, you'll risk losing some or most of it.
And if the goal you have in mind is one you want to achieve sooner rather than later, then it could pay to take a break from funding your brokerage account and put more money into savings.
Investing money you're not using is certainly a smart move. But sometimes, your savings might need your full attention. In these situations, you may want to focus on that.