Do you know the difference between saving and investing? In the world of financial planning, the terms “investing” and “saving” are sometimes used interchangeably. The ideas are the same – you’re spending time and energy on setting money aside for your future.
However, within your financial plan, it’s important to realize the difference between saving and investing and the purposes each serve. You can and should use both of these strategies to meet your goals, but it’s important to know how and where to leverage them in your own financial life.
What Does It Mean to Save?
Saving is a strategy that focuses on accumulating cash by making regular deposits into a bank savings account. Saving with a bank helps you secure your money through FDIC insurance, making it a low-risk way to accumulate wealth. The FDIC, or Federal Deposit Insurance Corporation, is an organization separate from the government that protects bank patrons against losing their money if the bank should go under.
FDIC-insured banks are the way to go for cash savings because the FDIC will protect your savings dollar-for-dollar including any insurance earned over the life of your account. The best part is that bank customers don’t have to do anything to apply for FDIC insurance. If the bank is insured, so are all account holders. Typically, traditional accounts are covered up to $250,000.
Growing cash savings in an FDIC-insured bank is a great way to boost your wealth and to meet short term goals. Because your money is insured dollar-for-dollar, and because you have easy access to cash in a savings account, this type of savings is ideal for meeting liquidity needs.
When Should You Save?
Saving plays a big part in your financial plan because most of your short-term goals can (and should) be met by cash savings. In a perfect world, you’ll always be able to save in advance for big, lifestyle-goal purchases. For example, you might start putting cash aside in an earmarked savings account for:
- A new (or new to you) car
- Holiday spending
- New furniture
- Concert tickets
- A house down payment
Saving cash in FDIC-insured savings accounts for short-term goals like these helps you to prioritize spending goals and avoid getting into debt to fund your lifestyle. Another way to leverage saving is to build a cash account for emergencies. Typically, financial experts recommend having 3-6 months of living expenses tucked away in an emergency fund that you don’t touch unless you absolutely need to.
However, this number can change depending on your current life situation. If you’re a freelancer or entrepreneur, for example, giving yourself a little bit more of a runway in your emergency savings can protect you against a lull in business, or losing your biggest client.
Of course, on the other side of the coin, it’s possible to have too much cash in savings. If the risk that comes with investing makes you uncomfortable, you might be sitting on a surplus of cash – which can prevent you from growing your wealth for important long term goals like retirement. A good rule of thumb to follow is that your savings should be dedicated to an emergency fund and short-term savings goals. Beyond that, your money will earn more for you in the long run if you invest.
What Does It Mean to Invest?
Investing is another tool in your financial plan that helps you grow your wealth. When you invest, whether it’s in the stock market or property, you’re putting your money in vehicles that earn a higher rate of return than a traditional savings account. High-yield savings accounts, on average, have a return of about 2% APY. Investing in the stock market, on the other hand, has historically earned investors an average return of 10% annually – closer to 7% if you want to be conservative in your projections.
Keep in mind that investing doesn’t come without its downsides. The tradeoff for a higher annual rate of return is that, when you invest, you’re taking on a lot more risk than you do in an FDIC-insured savings account. There is no insurance or guarantee when it comes to investing. Even if you choose lower-risk investments like bonds or property in an up-and-coming area, you’re still walking into a situation where the money you’ve invested could be worth less over time in a worst-case-scenario.
The stock market crash of 2008 is often something people reference when shying away from investing – and the truth is that there’s no clear guarantee that the market won’t crash again. Markets are meant to fluctuate over time, which is why it’s so important to invest responsibly and to focus on long-term goals instead of “get rich quick” investing strategies that may or may not work.
When Should You Invest?
Even though investing comes with more risk, it plays a big part in your financial plan. Investing is ideal for long-term goals and financial growth. Some long-term goals that might be a good fit for investing might be:
- Your child’s education expenses
- Creating a legacy for kids and grandkids
- Grow a nest egg to pay for your child’s wedding (or to gift them when they leave the nest)
One of the easiest ways to get started with investing is through your company’s retirement plan. In fact, for most people, their 401(k) is their first experience with investing. Within your 401(k) (or other retirement plan offered through your employer), you can adjust your investments based on your risk tolerance and retirement timeline. Beyond your employer’s retirement plan, you might also get some early exposure to investing through employee stock options like RSUs, or other incentive plans. If either or both of those investing vehicles are available to you, make sure you’re maximizing the opportunity.
Beyond investing for retirement, or having employee stock options, you could opt for another investing tool to help you diversify your portfolio and reach your long-term goals. A few investing accounts, or tools to look at are:
- Mutual funds
- ETFs (Exchange-traded funds)
- Property or real estate
- Hedge funds
- Private equity funds
Every investment type comes with its own unique risk. Before you jump into investing in any or all of the above, it’s important to take a step back and evaluate your long-term goals. Knowing the “why” behind a given investment can help you to decide whether a particular investment will work well in your overall portfolio.
Why Both Are Important
While understanding the difference between saving and investing is important, it’s even more vital to know that both have a spot in your financial plan. If you’re just getting started with your financial planning journey, it’s easy to fall into the trap of thinking that cash savings should be your primary (and only) priority, but that couldn’t be further from the truth. It’s important to build your cash savings, and continue to put money toward short-term savings goals to keep you out of debt while still checking some big lifestyle to-dos off your bucket list. However, it’s also important to get started investing early. Even a small amount of money in a retirement account can earn you notable compound interest over time.
When you look at how saving and investing play a role in your financial plan, it can be helpful to remember that growing your wealth is all about balance. You want to be able to reach short-term goals, like taking that family beach vacation next summer, because they make life worth living. You also want to be able to prepare for a successful financial future through retirement and beyond. Finding a way to balance both cash savings and a well-diversified investing strategy can help you further down the path toward your goals.
Have questions about finding a balance between saving and investing? Not sure where or how to get started with your wealth-building strategy? Let’s chat! Our team would love to talk to you about your goals, and how you can combine saving and investing to reach them.