Saving vs. Investing: The Proven Way to Choose

The question needs to be asked: What is more important, Saving vs Investing?

The amount of money you have saved that is easily accessible? or Your investment rate of return?

Your intuition is likely to say the latter option, as that seems to appear more lucrative. In many cases, we think more about how we can have a better yield on our investment. Saving is not really given a second thought, since that seems “boring”.

In actuality, however, saving undeniably affects most of the middle class.

Why?

Because most people have a hard time saving. And investing requires money, which is most commonly achieved through — you guessed it — saving. This statement is valid, regardless of if you make $5,000 or $50,000 a month. In the event that you spend all that you make, you’re left with nothing to invest.

There is a stark difference between saving and investing: Saving means depositing cash for later use in a safe place, like a savings account, for example. Investing involves purchasing assets that are projected to increase their value in the future and provide a greater return of cash than what you paid for them over the long term.

The best personal finance practice is to have at least 3-6 months of living expenses saved, but even that can be a daunting task, especially if you are struggling with maintaining a budget. If you are currently having difficulty managing your expenses, then take a look at how to get started managing your monthly spending. If you already have a good handle on everyday expenses, the next question then becomes: When do you prioritize saving, vs investing? The answer depends on your financial goals, how much time you have to achieve those goals, and how much risk you are willing to take. Read on to find out more including when to prioritize.

Saving vs Investing – Key Differences

Risk

To begin, the greatest difference between saving and investing is the level of risk. When you deposit money into a savings account, there is little risk of loss to the money that is deposited. There is also minimal gains that can be obtained with cash that is deposited in the savings account. Whenever you save, the money is typically readily available to be withdrawn at a moments notice (or at any point in the future). Whenever you invest, you have the potential for greater long term gains, but the potential risk of losses to your investment increases as well.

Due to the varying level of risk involved with each approach, you should have clarity on what your objectives are in order to figure out when to prioritize each approach. Picking the wrong approach could cost a lot of money.

Monetary Return (% Yield)

Another key difference between saving and investing is the yield on your investment, or commonly known as “how much money is this making?” The goal of investing is to make more money, while the goal of saving is to protect the cash and minimize any losses. It is for this reason that investing typically yields higher return than saving, which yields little to no-return.

Regardless of their apparent differences, saving and investing are equally important. You can be a great investor with a sizeable investment portfolio and investment properties, and still struggle to make ends meet because you don’t know how to save money for short term needs. On the flip side, you may set aside cash every month, but those savings won’t cover your retirement if they are not invested to outpace inflation. This ought to remind us how significant both savings and investing are. Generally, depending on your goals and time frames, you’ll need to both save and invest.

Saving vs Investing: When Should You Save?

Regardless of your financial situation, financial experts have always maintained that having enough money in your savings for emergencies should always be your first goal. That aside, saving should be prioritized in the following scenario:

If you will need the money in five years or less.

If you are saving for a down payment on a house, for example. Or maybe you are saving to pay for tuition, or any other significant financial obligation. In this case, the funds that are required should remain in a savings account, where there is minimal risk, as opposed to being invested in the stock market.

Pros and Cons of Saving

There are a lot of reasons you ought to set aside your well deserved cash. All things considered, saving comes with these advantages:

• Liquidity: Savings accounts are liquid, meaning that you can withdraw money as soon as you need it.

• FDIC Protection: The Federal Deposit Insurance Corporation (FDIC) guarantees bank accounts up to $250,000. This means that you will not lose any money when using a savings account.

• Predictable Interest: Savings accounts tell you upfront how much interest you’ll earn on your balance.

• Low fees: There are minimal fees. Maintenance fees are pretty much the only way a savings account at an FDIC-insured bank can lose value.

• No Hassle: Saving is generally straightforward and easy to do. There usually isn’t any upfront cost or learning curve. Deposit your cash, and that’s it.

Keep in mind that saving does have some disadvantages, namely:

• Low Returns: especially when compared to the investing approach

• Inflation: If your savings account fails to provide competitive interest rates, inflation could eat away at any interest gained, resulting in the value of your money decreasing over time

• Monthly fees: Most savings accounts have minimum balance requirements in addition to monthly maintenance fees. If your balance falls below requirements you could end up paying fees that will offset any interest that you have earned on the account

Saving vs Investing: When Should You Invest?

Ideally, you want to do your best to always be investing, even if it is lower on the priority list. But you should definitely consider prioritizing investing over saving, if:

You have an established, fully funded emergency fund:

Aim to have at least 3-6 months of living expenses saved, or 1 year’s expenses if you are in a single income household. Once you have this amount saved up, then you can proceed to fully focus on investing

You have paid off High-Interest Debt:

This does not include mortgages, or student loans as these are low interest. The highest culprit when mentioning high-interest debt is credit card debt. It makes zero sense to try to enter investments that return an average of 8-10% a year when you have debt collecting 20% interest.

You have long-term financial goals that will require a lot of cash:

Investing makes sense to prioritize if you have long-term objectives that will require a great deal of money. Especially if these are costs that won’t be realized for at least the next 5 years. This can be to fund retirement, or for a college fund.

Pros and Cons of Investing

Here are a few benefits of investing

• Higher yield: Investing in stocks for example, will give better returns than savings accounts. Over the long-term, the Standard & Poor (S&P 500) has returned an average of 10% annually, however the return can vary for savings accounts.

• Easy to get started: It is really easy to open an investment account and start depositing money. Nowadays, brokerages offer the ability to buy and sell stocks, bonds and ETFs at relatively low cost. Most do offer this feature for free though.

• Beat Inflation: If you have a well-positioned portfolio, chances are that you will easily beat out inflation over the long term, and further increase your buying power. On average, the inflation rate that the federal reserve tries to adhere to is 2%, but it has been a lot higher in recent years, which only further highlights the importance of investing over the long term. If your returns fail to keep up with inflation, then you are losing buying power over time.

With high returns comes high risk, and some cons to investing that you should be aware of include:

• Non-Guaranteed returns: Investing does require some mental fortitude, and a lot of patience, as returns are not guaranteed. In some cases you will some money in the short term as of your assets will fluctuate in value.

• Money should not be withdrawn for at least 5 years: Experts have determined that this is the the average time to start to see gains on your investments, as well as time required to ride out any short term volatility. A general rule of investing though is to buy and hold for as long as possible anyway; which means no withdrawals any time soon

• Investing Fees: Fees can be higher on investing accounts. You might have fees associated with minimum balance requirements, or you might be charged commissions on each trade that you make. Majority of brokers offer free trades, but this depends on your area as there are still some brokers that charge commissions.

Mark this down: The Bottom Line

Saving is better for emergency or short-term financial needs, for example, if you don’t an emergency fund, or if you plan on using the funds within the next 5 years

Investing is better for long term, i.e. money that you will need at least 5 years out. You can be more aggressive with your approach, depending on your risk tolerance. When you keep your money invested for longer, you give the opportunity to maximize your returns. While investing can seem complicated, it is actually quite easy to get started.