Saving vs. investing, explained

Saving vs. investing: Both aim to grow your money over time but in different uses or time frames. Understanding the difference between saving and investing is key to making more informed financial decisions and learning how to potentially use them together. Let’s look at how each method works and their pros and cons.

What is a savings account?

A savings account is a bank account designed to encourage long-term saving. They may accrue interest over time, paying a percentage of their balance at regular intervals, and typically limit withdrawals and transfers. Generally, many individuals consider savings accounts to be less volatile compared to investments as their value is untethered to the value of companies or underlying commodities.

There are various types of savings accounts, each one suited for different purposes. Certificate-of-deposit (CD) accounts might be useful for those seeking stable, predictable returns and who don’t mind sacrificing accessibility. A high-yield savings account is a savings account that funds more regular expenses through checking transfers and may provide higher returns than traditional savings accounts. As an account offered by a bank, the deposits are FDIC insured up to applicable limits and there’s little to no risk in depositing your money in a saving account.

What does it mean to invest?

Put simply, investing is buying assets with the expectation that their value will appreciate with time or they can provide a steady stream of income over time. Investment can take many forms, such as stocks, bonds, mutual funds, exchange-traded funds and more. Each investment vehicle offers its own mix of potential risk and reward. Stocks, for example, are considered more volatile than bonds because their value tracks the success of a single company. Some other investments like mutual funds or exchange traded funds invest in a basket of different securities, which provide diversification in a single investment and may be less volatile than a single stock or bond since the performance of the underlying portfolio can reduce the volatility. Because of the different types of investment options available, it’s important to understand your risk tolerance, investment objectives and time horizon before you invest – and which investment goal may align best with your goals. Because of market volatility, there is risk involved in investing, including losing your principal.

The difference between saving and investing

Savings accounts generally emphasize stability and are income vehicles, whereas investments aim for higher returns and can either provide income, growth or some of each. For cash you need in the shortterm or for storing emergency funds, savings accounts are best. Investment accounts are better for longterm wealth generation. Let’s look deeper at the difference between saving and investing and some pros and cons for each.

Pros and cons of savings accounts

Pros:

• FDIC insurance: Savings accounts at FDIC-insured banks are insured up to the maximum amount allowed by law.investment-past-performance
• Access to funds: Savings accounts are designed to allow for convenient access to money, making them well-suited for short-term needs and emergency funds.
• Stability: The value of the funds in your savings account are not subject to market loss and will not drop in value.

Cons:

• Modest returns: The interest rates on savings accounts are generally lower than the returns of other types of investments — sometimes not enough to outpace inflation. This may erode the purchasing power of your money over time.
• Limited growth potential: Savings accounts generally offer lower growth potential than many investments, limiting their capacity to build wealth.

Pros and cons of investing

Pros:

• Higher potential returns: Certain assets have the potential to generate higher returns compared to traditional savings, especially with longer time periods. Positive performance however is not guaranteed.
• Possibly help mitigate the impact of inflation: Some investments tend to outpace inflation. This makes them worth considering for possibly maintaining or potentially increasing the purchasing power of your money.

Cons:

• Risk of loss: Investing comes with a risk of losing some or all the invested funds, particularly in more volatile markets.
• Complexity: Making an informed investment generally requires knowledge and understanding of financial markets and the specific investment vehicles, which is challenging for some individuals.
• Liquidity Considerations: While investments are generally liquid, they often have fees and charges that can reduce your principal. They may also lose value due to market volatility. If you sell an asset that appreciated in value, you also may owe taxes. Finally, some investments may have restrictions on when they can be sold.

Should I save or invest?

To determine whether you should save or invest, it’s generally recommended to first determine your financial goals. Understanding what you want from your money, and when, may help provide insight into your time periods and risk tolerance. This may help highlight the saving and investment options that might be suitable to achieve your goals.

When to save

Why put money in a savings account? You might choose to use one for a few reasons:

• You’re building an emergency fund: Before investing, it may be wise to establish an emergency fund with three to six months worth of living expenses. This may be helpful for not only supporting yourself during periods of low or no income, but also for protecting existing investments from liquidation in the case of financial hardship.
• Your risk tolerance is low: Savings accounts are generally considered low-risk, though low reward. If the prospect of potentially losing some of your funds outweighs the chance for higher rewards, saving might be a safer option.
• You need cash available: Because your funds remain relatively accessible, savings accounts could be useful when stable cash flow is desired.
• You have short-term goals: Savings accounts might also be useful for shorter time periods where inflation is less likely to prevent your progress and investments have less time to mature.

When to invest

Why would you invest your money? Typically, investment aims for long-term growth and the pursuit of higher returns than saving. Here’s a few situations where investing might be more appropriate:

• You’re comfortable with risk: Investing generally offers higher growth potential than saving, however with the potential to lose some or all the invested funds. Different investments have different levels of risk. For example, stocks are generally considered riskier than bonds.
• You want to diversify: There are opportunities to spread your money across different types of investments and multiple markets. This leaves your investments’ value less subject to the fluctuations of singular assets. Diversification and asset allocation does not guarantee a profit or protect against a loss.
• You have long-term goals: For major milestones with longer time periods, investing may offer better growth potential than saving. There are also many different investment types catering to specific goals, such as retirement or paying for education needs.

Combining saving and investing

The question of “Should I save or invest?” can sometimes be misleading; saving and investing are often used together to pursue a variety of different goals. Saving is often used to help meet immediate needs and maintain financial stability. Investing is generally considered a potential way to grow funds for future more long-term goals.

In summary

Saving vs. investing is a decision many individuals make in their financial journey. By understanding their different mechanisms, advantages and limitations, you may be better equipped to align your financial strategy with your personal goals. Whether you’re seeking the stability of savings or the potential rewards of investing, knowledge is the key to more informed decisions.