What’s the Difference Between Saving and Investing?
August 23, 2016 | Your Finances
A penny saved is a penny earned, as Benjamin Franklin is credited with saying. But a penny invested could actually become many pennies.
If you haven’t already, it’s important to develop a habit of saving and investing. Save for short-term goals (including an emergency fund), but don’t forget long-term goals—paying for kids’ college, retirement, home. Start early so money has time to grow, and try to automate your savings as much as possible. That will allow you to pay yourself first and spend what’s left rather than spending first and saving what’s left each month.
When you’re setting your money aside for the future, it’s important to be strategic about where you save your money by saving some and investing the rest.
What does that mean? Saving is setting aside money in safe accounts where it is unlikely to lose value. Investing involves taking on the risk that you could lose your money in exchange for the likelihood that you will earn a return (more money) on the amount you invest.
But there is a trade-off for that security. In exchange for the guarantee that your savings won’t go down, you will likely receive a low interest rate. Your money won’t grow much over time, and you might lose value. That’s because as prices rise due to inflation, the value of your money can decrease because it will cost more to buy the same things.
What Do You Save for?
Savings accounts allow withdrawals at any time. Money you put into these accounts should be for short-term expenses (a home upgrade you’re planning in the next year or an upcoming vacation) or emergencies (like an unexpected health problem or car repairs). This is money you can’t afford to lose.
What Do You Invest for?
Investing is putting money aside for the longer term for things like retirement, college tuition or a new home that you plan to purchase years from now. Investments carry more risk that you will lose value but over time have the potential for a greater increase. In exchange for the tolerance of fluctuations in the value of your money and the possibility that you could lose money, you may be rewarded over a longer period of time with greater returns than you would have made with a traditional savings account.
The Big Difference Between Money Saved and Money Invested
If Mary and Jim put $1,000 in a traditional savings account, they are guaranteed to have their $1,000 plus a small amount of interest. If their money earned a 0.2 percent interest rate of return, which is typical in a low interest rate environment, in a decade their $1,000 would have grown to $1,020.18.
Investing $1,000 would mean accepting some risk that Mary and Jim could lose some or all of their money. But there is also the possibility that their investment will have grown in 10 years. If they earned a 7 percent annual return, with compounding their investment would have increased to $1,967.15. That’s nearly twice as much money than if they had saved that $1,000.
If Mary and Jim are too conservative and put all of their money in a savings account, they risk missing out on the higher rate of return that can come from investing. In addition, when you factor in inflation, the amount of goods or services they could buy with their $1,000 is likely to decrease in 10 years.
On the other hand, if they place all their money in long-term investments, they risk losing value. And their money won’t be readily available if they need it. But there is a good possibility that they will earn money on the money they have invested, meaning they will have even more money available to spend after the 10 years.
What’s the Best Approach to Saving and Investing?
Throughout your life you’ll need a mix of both saving and investing strategies to provide for both short- and long-term needs.
It’s a good idea to open a savings account and start making monthly contributions to it. A great place to start investing is by contributing to a retirement plan like a 401(k).
There are many different ways to save and invest. Learn more in our free guide, Building the Foundation for a Solid Financial Plan. A financial advisor can help you find the balance that works best for you and build a comprehensive plan to help you achieve your financial goals today and for years to come.