Are you unsure of the differences between saving and investing? Perhaps you have some money that you want to put to work but aren’t sure how. These are the main differences between saving and investing your money.
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Understanding your goals
Before deciding to save or invest you need to have clear set goals. Savings goals are typically for the short-term while investing is a long-term strategy. Look at your current financial circumstances holistically. Consider your obligations like debt and fixed expenses to come up with a realistic amount that you can allocate for saving and investments each month.
Short-term Savings
When to save money
If you are saving for something like a vacation or a house, you don’t have the wiggle room in your timeline for your money to lose value and fluctuate with the market. In this case you would be better off putting your money into some form of a savings account. This could be a high yield savings account, money market account, or certificate of deposit. Funds that you need immediate access to and cannot afford to risk in the market should be kept in savings.
Your emergency fund is an example of something to keep in savings. The purpose of an emergency fund is for it to be readily available if necessary. While your emergency fund should be placed in a savings vehicle so that it keeps up with inflation, the goal is not to earn an income from it. By keeping your money in savings you are preparing for an unplanned expense while receiving a low return.
Savings Accounts and Interest Rates
If you keep your money in a savings account, the interest rate that the bank will offer you will be based on the Federal Funds Rate. Since banks are businesses, they have to factor in their profit margin when setting the interest rate they offer to their customers. If market interest rates are at low levels, this means that they will in turn have to lower their rates to borrowers. If market rates are high, banks have more flexibility in how generous they can be to their savings account holders.
There will be a point in your financial journey where keeping your money in cash is not advantageous for your long-term goals. Like Warren Buffet says “If you don’t find a way to make money while you sleep, you will work until you die”.
Within the past 10 years the highest the Federal Funds Rate has been is 2.42%. In the last half of 2019 there were issues in the repo market that required the Fed to take action. The interest rate has been on the decline since that point.
Due to the economic shutdown caused by the COVID-19, Jerome Powell, the Chair of the Federal Reserve has pledged that the Federal Funds Rate will stay at its low rate through 2022. If you are relying on a savings account to grow your money, you will be very disappointed with the results.
If you look at the pattern for how the Federal Funds Rates has fluctuated over time, the pattern is on a downward trend. With each recession that the US has faced, the rates get lower and lower. Jerome Powell has stated that he does not believe that negative interest rates would work in the US. However, with near zero rates, people need to look for alternative ways to get a return on their money than just a savings account.
Transitioning from saving to investing
If you are very risk adverse it can be stressful transitioning from saving to investing. While the returns are not as high in a savings account, there is not the concern of losing your investment. This is due to the fact that reputable banks are FDIC insured. However, it can be just as stressful to have your money producing low returns that cannot provide you a good source of income in the long term. If you are looking at the long term scenarios such as retirement, you will need some form of investment to live comfortably.
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Long-term Investing
Some of the many reasons to invest for the long term include building wealth, building passive income, and planning for retirement. Let’s break down each one:
Build Wealth
If your goal is to become wealthy, it will become incredibly hard to do that based on your salary and savings alone. People typically become rich not just from working for money but having their money work for them. The average millionaire has at least seven streams of income. Many of these streams are passive once the initial investment is made. If you are in a position where your money is working for you, there is more time to enjoy what life has to offer. One main goal with investments is to build them up so that they are producing cash flow. You can continue to let your assets grow and only enjoy the cash flow it is producing.
Retirement Planning
While planning for retirement, you will want your money in some kind of investment vehicle. Don’t believe me? Try calculating 15% of your income and multiply it by 40 years of working. Is that amount enough to live on in your old age for roughly 20 years? For most people, it won’t be enough. This is why it is extremely important to start as soon as possible when it comes to retirement planning. Open a retirement account and come up with an amount that works with your budget. It is also important to recognize that it is never too late to save for retirement. If you are older, talk to a financial advisor on the best ways to allocate your money for a short time horizon.
Passive Income
Passive income is a great way to diversify your income. There are so many different ways to build passive income. Some of the most common ways are dividend and interest investing, royalties, affiliate marketing, and real estate. For example, if you were to invest in a long-term rental property you reap the benefits of a passive income stream from the rent and the appreciation of the property. This allows you to have your money invested in something that creates value for others while the price of the asset increases over time.
Your funds may be tied up for a while
Common forms of investments include the stock market, real estate, or owning a business. No matter which investment you are looking at, you will need a time horizon for your goals. One of the main differences between savings and investing, is that a savings account is typically in some form of cash and is thus highly liquid. Many investments do not have high liquidity. When setting money aside for an investment, you should have expectations on your upfront cash investment and what type of return you expect to receive. Understand that you may not be able to gain access to that money at your leisure. If you take your money out too early, you could be missing out on an opportunity to make more money.
For example, if you put your money in the stock market, you are subject to your principal investment lowering in value. You don’t want to pull your money out while it is down. You also don’t want to miss out on an opportunity for your money to grow more. Money that you don’t need immediate access to or that you can afford to lose can be put into investment opportunities.
While nothing is guaranteed when investing, the stock market is an example of an asset class that continues to go up over time. If you want your money to retain its value, it is important to store it in assets that are appreciating.
What are your savings and investing goals? Let me know in the comments!
Disclaimer: The content in this post is my opinion and should not be considered financial advice. I am not a financial expert or advisor. This content is for informational and educational purposes. For more details please visit the Disclaimer Page.
