Investing vs. Savings
The terms investing and saving are frequently used interchangeably. But the reality is that, even though both are important, there is a big difference between the two financial concepts.
It is essential to have a good understanding of how investing and savings differ, as well as how they are alike. This can help you to choose the right tools based on your short- and long-term financial and retirement plan objectives.
The Key Differences Between Investing vs. Savings
While investing and saving will require you to put forth an amount of money, these acts can result in different outcomes. They can, however, work together to help you achieve your financial goals.
Savings Defined
Saving is defined as “the act of putting away money for a future expense or need.” For example, many people set aside money for the down payment on a home, the purchase of a new vehicle, or the future college tuition for a child or grandchild.
In some cases, saving may have a shorter-term time horizon, such as building up funds for a vacation or putting money into an account like a “Christmas fund,” so you don’t have to rack up a great deal of credit card debt when purchasing holiday gifts for loved ones.
In addition, an emergency fund is an integral part of an overall financial plan. For instance, having the equivalent of 6-12 months of income stored away could help to pay for unexpected events like a car repair or a new roof. It can also prevent you from having to put these types of items on a high-interest credit card.
Money considered “savings” is often stored in a savings account at a bank or credit union or in a money market account where it can earn interest and be easily accessed.
Another popular savings vehicle is the certificate of deposit (CD). These require you to keep your money invested for a certain period or maturity. These time frames can range from just a few months to several years. The longer the maturity, the higher the rate of return will typically be. But you can risk paying an early withdrawal penalty if you access your funds before a CD has reached its maturity.
When you put money into a savings or money market account and a certificate of deposit, you typically know how much interest you will earn. Therefore, the process of saving is reasonably straightforward to understand.
Savings can also provide you with certain types of guarantees, such as FDIC insurance. The Federal Deposit Insurance Corporation (FDIC) guarantees bank accounts up to $250,000 per depositor, per insured bank, for each account ownership category. (There is no charge for this protection). So, if the bank goes under, some or all of your savings will still be safe.
Understanding Investing
Investing also requires you to put money aside. But in this case, the purpose is usually to grow the funds through financial vehicles like mutual funds and stocks. For example, the S&P 500 stock index (S&P 500) has returned approximately 10% annually over time. But this is just an average, as the annual return can fluctuate greatly both up and down.
There are many more advanced investing concepts, such as options and futures. You will typically have to work with an investment broker for these transactions. However, various online trading platforms are available today that allow you to conduct the entire process online.
So, how are the concepts of saving and investing genuinely different?
There are actually several ways.
One of the biggest differences between saving and investing is the level of risk that is taken. For instance, most savings vehicles provide principal protection, often in any type of stock market or economic environment.
But as a “tradeoff” for this safety, the return generated is typically relatively low and is generally too small to meet inflation, much less beat it. So, this can result in erosion of your account value and a loss of future purchasing power.
In most cases, the money that you have in savings can be easily accessed without incurring a penalty. This can make savings a good option for storing funds that may be needed in the short term.
On the other hand, investing can allow you to earn a higher rate of return. However, in many cases, the higher the potential return, the more risk you take.
As an example, investing in start-up companies could be highly profitable. But if the company goes under, you risk losing your entire investment. The stock market, in general, can also be highly volatile, so it is essential to have a higher risk tolerance if you plan to put a portion of your money into equities.
While some investments can give you a quick return, for the most part, it is recommended that you look at investing as a longer-term strategy of at least five to ten years. This can help with averaging the possible positive and negative returns generated. With that in mind, it is recommended that you not invest money that you may need for everyday expenses or emergencies.
The complexity of the financial products can also differ based on whether you are saving or investing. For instance, money placed into a savings or money market account will typically earn a fixed interest rate over time.
However, investments can have many “moving parts,” especially if you are using more complex vehicles like variable annuities, exchange traded funds (ETFs), or options. So, even though these products could work well in your portfolio, it is recommended that you work with a financial professional who can provide you with the pros and cons and also inform you on what to anticipate in different market situations.
Because investments have the opportunity to generate a high return, vehicles like stocks and growth mutual funds could be used as a hedge against inflation. The right allocation of high- and low-return alternatives can help you balance risk and reward.
Another big difference between saving and investing is the potential charges you incur. For instance, a commission is often paid to an insurance or financial advisor when you purchase stocks, mutual funds, and other investment vehicles. It is also possible to incur “early withdrawal” or “surrender” charges if you access some or all of your money before a certain period has elapsed.
It is also common for investors to incur money management fees yearly, quarterly, or monthly. Depending on your overall account value, these charges could range from 1% to 3%, with higher account values usually being charged less.
Although these fees may not seem high, over a long period, they could significantly erode your overall return and the amount of money you have as a “base” for generating a stream of retirement income.
On the other hand, many savings and money market accounts will not charge any fee. However, they may require you to keep a minimum balance in the account or make a certain number of transactions in a given period.
Investing versus Saving
| Investing | Savings | |
|---|---|---|
| Level of risk | May be high | Low |
| Return (or potential return) | High | Low |
| Known rate of return | No | Yes |
| Financial vehicles used | Stocks, mutual funds, bonds | Savings accounts, money market accounts |
| Type of account | Brokerage | Bank / Credit union |
| Principal protection | No | Yes |
| Volatility | Can be high | Low |
| Time horizon | Long (ideally 5 or more years) | Short |
| Liquidity / Accessibility | Low (often incurring a penalty) | High |
| Hedge against inflation | High (but no guarantee) | Low |
| Difficulty / concept of financial vehicle | Can be high | Low |
| Charges / fees | Yes | Not always |
| FDIC insured | No | Yes |
Are You Maximizing Your Savings and Investing Strategies?
It is essential to include both saving and investing strategies during your working years and after you retire—and coordinating your savings and investing together is a key component to a good, solid overall retirement planning strategy.
But there isn’t just one type of financial vehicle or strategy that will work well for everyone across the board. This is because different people can have vastly different financial objectives, risk tolerance, and timeframe until retirement.
Because of that, it is recommended that you work with a financial professional who can help you develop a complete plan and then choose the right tools to move you toward your goals.
If you would like to schedule a time to talk with a retirement planning specialist, please feel free to contact us directly by phone at <phone number> or via email by going to <email address>. We look forward to assisting you.
