The act of saving is defined as setting aside money into a secure place (i.e., saving account) designated for future investment. The goal of saving is simply to protect your funds on deposit while providing access to those deposits whenever they are needed.
There is often a goal or objective associated with your savings. These usually include some type of expense that will occur in the next one (1) to five (5) years from today. These include:
1. Emergency savings
2. New phone/laptop
3. College Expenses
4. Vacation expenses
5. Home repair expenses
Saving Advantages
1) Safety
A typical savings account is a safe place to store your savings, and your money should have less risk of losing value in less time.
Example: If you deposit $500 or more into a bank account, you can always go to your bank to get your money.
2) Convenient Withdrawal
Your savings are immediately available if there is an emergency or any other unexpected expense; therefore they are easy to withdraw from.
Example: If your car has to be repaired after an emergency as they unexpectedly occurred, then you will be able to pay for the repairs using your savings.
3) Lower Risk
Compared to other means of accumulating wealth, saving is a much less risky way of accumulating wealth.
Disadvantages Of Saving
The primary disadvantage of saving money is that it grows slowly. The interest you earn on your savings account is normally much lower than the rate of inflation. Therefore, your savings will lose value over time.
Example: If inflation is 5%, but your savings account pays just 2%, then your savings will decrease in value in real terms.
What is Investing
Investing entails committing funds to asset classes likely to appreciate in value in the future. The most common investments are equity (stocks), debt (bonds), mutual funds, real estate, and businesses.
The long-term goal of investing is to increase one’s net worth (wealth) by using money to generate additional money.
There are several common reasons for an individual to invest, including:
- To have money available at the time of retirement
- To accumulate funds for a future home purchase
- To accumulate wealth over time
- To save for their child(ren)’s post-secondary education
- To attain financial independence
Benefits of Investing
1. Greater Than Average Return
You can typically earn a higher yield on an investment than you can in a savings account.
For instance, you may have an investment in a stock that experiences tremendous price appreciation over several years, thus increasing the amount of wealth you possess.
2. Protects Against Inflation
By investing, you will often earn a return above inflation in the long term.
For example, if an investment yields 8% while inflation runs at 3%, you would gain in real dollar value compared to the previous year.
3. Wealth Accumulation
Investing allows your initial investment to earn compounded growth through time.
For instance, an investment that throws off returns every year can grow substantially larger than the initial funds used to purchase the investment.
Disadvantages of Investing
Investment includes chance. Investments’ worth can go up or down based on economic state.
Example: $1,000 stock investment today could potentially lose its worth to $800 during an economic downturn.
Compare: Saving Vs. Investing
Saving Investing
Less risk Higher risk
Readily access money Harder to access money
Short Term goals Not as likely to have short-term goals
Low returns High returns
Safeguards money Grows money
Keeps money typically in bank account Typically keeps money in stocks, mutual funds, real estate, or business
4 Reasons To Save
1. Need money quickly (less than 3 months or within 3 months),
2. Creating an emergency fund,
3. Want to have no financial risk,
4. Need money for temporary purchase. )
5 Reasons To Invest
1 . Have long-term Financial Goals,
2. Keep money aimed at growing for 3-5+ years,
3. Want to increase the speed of money growth,
4. Accept some risk in exchange for greater gains.
Importance of Both Saving & Investing
Saving and investing are complimentary rather than competing against each other. A comprehensive and complete financial program will include a portion allocated to both.
The first step to creating a well-rounded financial program is to generate an emergency reserve by saving money. After you have generated enough savings to provide for any unexpected emergencies and established a sufficient amount of savings for your short term needs, you can start to use the excess funds that you’ve put away for both savings and spending to invest in long term growth.
For example: you could have an emergency fund of 6 months worth of your living expenses sitting in a savings account and you could use additional excess funds that have been set aside over the course of time to invest in stock mutual funds or real estate.
In Summary
Saving vs. Investing is mostly dependent on your goals and risk tolerance and the time frame in which you plan to utilize the funds. The main purpose of saving is to protect money so that it will be readily available when needed. Due to this fact, saving is typically better suited for short term goals and for preparedness for emergencies. Investing by design is to build upon your savings with time therefore creating long term financial goals. Understanding how both savings and investments work in combination together will allow for building a strong financial future and achieving financial success.