Saving vs. investing: Here are the key differences for managing your money

Saving and investing are both important, but they’re not the same thing. While both can help you achieve a more comfortable financial future, consumers need to know the differences and when it’s best to save and when it’s best to invest.

The biggest difference between saving and investing is the level of risk taken. Saving typically allows you to earn a lower return but with virtually no risk. In contrast, investing allows you to earn a higher return, but you take on the risk of loss in order to do so.

Here are the key differences between the two – and why you need both of these strategies to help build long-term wealth.

Saving vs. investing explained

Saving is the act of putting away money for a future expense or need. When you choose to save money, you want to have the cash available relatively quickly, perhaps to use immediately. However, saving can be used for long-term goals as well, especially when you want to be sure you have the money at the right time in the future.

Savers typically deposit money in a low-risk bank account. Those looking to maximize their earnings should opt for the highest annual percentage yield (APY) savings account they can find (as long as they can meet the minimum balance requirements).

Investing is similar to saving in that you’re putting away money for the future, except you’re looking to achieve a higher return in exchange for taking on more risk. Typical investments include stocks, bonds, mutual funds and exchange-traded funds, or ETFs. You’ll use an investment broker or brokerage account to buy and sell them.

If you’re looking to invest money, you should plan to keep your funds in the investment for at least three to five years. Investments can be very volatile over short periods of time, and you can even lose money on them. So, it’s important that you only invest money that you won’t need immediately, especially within a year or two.

The table below summarizes some of the key differences between saving and investing:

Account typeBankBrokerage
ReturnRelatively lowPotentially higher or lower
RiskVirtually none on FDIC-insuredVaries by investment, but there is always the possibility of losing some or all of your investment capital
Typical productsSavings accounts, CDs, money-market accountsStocks, bonds, mutual funds and ETFs
Time horizonShortLong, 3-5 years or more
DifficultyRelatively easyHarder
Protection against inflationOnly a littlePotentially a lot
Expensive?NoCould be, depending on your account and how much your buy and trade
LiquidityHigh, unless CDsHigh, though you may not get the exact amount you put into the investment depending on when you cash in

How are saving and investment similar?

As you can see in the table above, saving and investing have many different features, but they do share one common goal: they’re both strategies that help you accumulate money.

“First and foremost, both involve putting money away for future reasons,” says Chris Hogan, financial expert with Ramsey Solutions and author of Retire Inspired.

Both use specialized accounts with a financial institution to accumulate money. For savers, that means opening an account at a bank or credit union, such as Citibank. For investors, that means opening an account with an independent broker, though now many banks have a brokerage arm, too. Popular investment brokerages include Charles Schwab, Fidelity and TD Ameritrade, as well as online options like E*Trade.

Savers and investors both also realize the importance of having money saved. Investors should have enough in a bank account to cover emergency expenses and other unexpected costs before they tie up a large chunk of change in long-term investments.

As Hogan explains, investing is money that you’re planning to leave alone “to allow it to grow for your dreams and your future.”

How are saving and investing different?

“When you use the words saving and investing, people – really 90-some percent of people – think it’s exactly the same thing,” says Dan Keady, CFP, and chief financial planning strategist at TIAA, a financial services organization.

While the two efforts share a few similarities, saving and investing are different in most respects. And that begins with the type of assets in each account.

When you think of saving, think of bank products such as savings accounts, money markets and CDs – or certificates of deposit. And when you think of investing, think of stocks, ETFs, bonds and mutual funds, Keady says.

The pros and cons of saving

There are plenty of reasons you should be saving your hard-earned money. For one, it’s usually your safest bet, and it’s the best way to avoid losing any cash along the way. It’s also easy to do, and you can access the funds quickly when you need them.

All in all, saving comes with these benefits:

  • Savings accounts tell you upfront how much interest you’ll earn on your balance.
  • The Federal Deposit Insurance Corporation guarantees bank accounts up to $250,000, so while the returns are lower, you’re not likely to lose any money when using a savings account.
  • Bank products are generally very liquid, meaning you can get your money as soon as you need it, though you may incur a penalty if you want to access a CD before its maturation date.
  • There are minimal fees. 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 savings account at an FDIC-insured bank can lose value.
  • Saving is generally straightforward and easy to do. There usually isn’t any upfront cost or learning curve.

Despite its perks, saving does have some drawbacks, including:

  • Returns are low, meaning you could earn more by investing (but there’s no guarantee you will.)
  • Because returns are low, you may lose purchasing power over time, as inflation eats away at your money.

The pros and cons of investing

Saving is definitely a safer move than investing, though it may not mean the most wealth in the long run.

Here are just a few of the benefits that investing your cash can come with:

  • Investing products such as stocks can have much higher returns than savings accounts and CDs. Over time, the Standard & Poor’s 500 stock index (S&P 500), has returned about 9% annually, though it can fluctuate greatly in any given year.
  • Investing products can be very liquid. Stocks, bonds and ETFs can easily be converted into cash on almost any weekday.
  • If you own a broadly diversified collection of stocks, then you’re likely to easily beat inflation over time and increase your purchasing power. Currently, the target inflation rate that the Federal Reserve uses is 2%. If your return is below the inflation rate, you’re losing purchasing power over time.

While there’s the potential for higher returns, investing has quite a few drawbacks, including:

  • Returns are not guaranteed, and there’s a good chance you will lose money at least in the short term as the value of your assets fluctuates.
  • Depending on when you sell and the overall economy, you may not get back what you put into the investment.
  • You’ll want to let your money stay in an investment account for at least three years, so that you can ride out any short-term downdrafts. In general, you’ll want to hold your investments as long as possible – and that means not accessing them.
  • Because investing can be complex, you’ll probably need some expert help doing it – unless you have the time and skillset to teach yourself how.
  • Fees can be higher in brokerage accounts. You’ll often have to pay to trade a stock or fund, though some brokers offer free trades. And you may need to pay an expert to manage your money.

So which is better – saving or investing?

Neither saving or investing is better in all circumstances, and the right choice really depends on your current financial position.

Generally, though, you’ll want to follow these two rules of thumb:

  • If you need the money within a year or so or you want to use the funds as an emergency fund, a savings account or CD is your best bet.
  • If you don’t need the money for the next three years or more and can withstand a complete loss, then you can invest the money.

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).

“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 saving.”

And it’s the same for an emergency fund, which should never be invested but rather kept in savings.

“So if you have an illness, a job loss or whatever, you don’t have to resort back to debt,” Hogan says. “You’ve got money you’ve intentionally set aside to be a cushion between you and life.”

And when is investing best?

Investing is better for longer-term money – money you are trying to grow more aggressively. Depending on your level of risk tolerance, investing in the stock market, exchange-traded funds or mutual funds may be an option for someone looking to invest.

When you are able to keep your money in investments longer, you give yourself more time to ride out the ups and downs of the market. So, investing is an excellent choice when you have a long time horizon (ideally many years) and won’t need to access the money anytime soon.

“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.”

While investing can be complex, there are easy ways to get started. The first step is learning more about investing and why it could be the right step for your financial future.

The post Saving vs. investing: Here are the key differences for managing your money appeared first on Bankrate and is written by James Royal

Original source: Bankrate

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