Saving and investing are both paths that can help you reach your financial goals. So, how do you know when to invest and when to save? There is a difference between the two, and there are times when it’s better to do one over the other.
Why is it important to do financial planning?
Financial planning can help clear the air, helping you prioritize between investing and saving. Typically, financial planning involves a long-term strategy to accomplish your goals while navigating expenses throughout every stage of your life. Planning can help to determine monthly savings, investments, and how to handle financial obstacles in a more effective way.
Financial planning makes life easier in many ways. It’s important when it comes to income management, it improves cash flow, it leads to better investments, it takes inflation into account, and it ensures a secure retirement plan. Most financial plans are based on long-term goals, risk tolerance, and your specific situation.
Let’s first look at the importance of investing, then compare it with scenarios where savings makes more sense.
Why is it important to invest?
There are several reasons to invest. But chief among them: investing helps you build wealth over time. Regularly investing money and holding it long-term is a great way to make your money work for you. That’s because investing money in a well-managed balanced way usually yields higher returns than putting money into a savings account.
Investing can also help save on taxes. By contributing to a 401(k) plan or a traditional IRA, you can reduce your taxable income. You’ll typically see a larger return on your money with investing, so you’ll reach major financial goals faster too, like buying a home or retirement.
Investing is a way to actively take charge of your financial security. It enables you to grow your wealth and, in some cases, to create other streams of income.
How can you start investing?
When you first start investing, you’ll need to figure out your financial goals. A financial advisor or a robo-advisor can show you common goals, then build an investment strategy for you.
Most Americans start investing through a 401(k) fund provided through their employer. These funds have historically performed well using a balanced, diversified approach, dividing your investments between low- and high-risk opportunities and regularly re-distributing money to meet the fund’s performance goals. They’re professionally managed, which means most Americans don’t actually take part in their own investment decisions, instead making regular auto-deposits and leaving the rest in the hands of fund managers.
Investments through 401(k) funds are often designed for long-term performance. They’re built, principally, for building wealth for retirement through a strategic mix of stocks, bonds and other tools. With the long-term in mind, your investments can typically weather periods of slower growth, or even losses, while other years offer faster returns.
In recent years, many investors have been going it on their own, using low- or no-fee services to make investments without a broker or an advisor. If you know what you’re doing, have clear goals and can monitor the markets and your investments closely, solo investing can be rewarding.
For short-term goals two years or less, you’ll want to stick with very safe investments, like bonds. You don’t want to risk slow-growth periods, or even losses, so it’s best to stick with secure investments that may not perform as well as other investments. High-interest savings accounts are also a good option for goals that are at two years or less.
Why is it important to save?
Building your savings is a smart way to manage both planned and unexpected expenses. In a savings account, your money is easy to access with no or low fees (while investments can take days to access and sometimes come with penalties).
Savings are great for emergency funds, scenarios where you’ll need your money quickly. They’re also ideal for planned purchases, like a car or a vacation or even a special splurge. When you save strategically, for specific goals, you can avoid relying on credit cards and the interest charges that come with them. Start saving for your goals now, then spend it when you have it.
Saving also offers the magic of compound interest. Compound interest is the “magical” effect of regularly adding the interest you earn on your savings back into your savings – and in turn, earning more interest based on the resulting higher amount.
One more benefit to saving: most savings accounts are FDIC-insured up to $250,000. That means your deposit stays safe, while investments typically have no safety net, with the potential for losing the money you invest.
How can you start saving more?
You can start saving more money building it into your monthly budget. Make saving a priority, just like you prioritize essential spending. Take a look at the 50/20/30 plan, where 20% of your take-home pay is dedicated to building your savings.
You can also save more by paying off your credit cards. The less money you spend on interest charges, the more you can dedicate to building your savings. Consolidating your credit card debt can help lower your interest charges too.
Pay for everything with cash. This makes it easier to track what you’ve spent and how much you have left. Credit cards can be too easy to use. If you use strictly cash – and stick to a budget – you can’t keep spending after you reach your limit. With less discretionary spending, you’ll have more to add to your savings every month.
Saving vs Investing?
The biggest difference between saving and investing is the risk involved. There is no risk involved with money in a savings account. Most savings deposits in the US are FDIC-insured up to $250,000.
In contrast, with investments, there’s always some risk you could lose your money. There is no government safety net for investments, and historically, the trade off has been worth it. Investments expose you to the risk of losing your money, but in exchange, your money will probably grow faster than the interest earned in a savings account.
The first thing to consider is an emergency fund. If you don’t have an emergency fund (enough to cover 3 to 6 months of expenses), focus on building your savings for that. Also, if you’re going to access the money within 2 years, consider using a savings account, for easier access and safer earnings.
Investing is for long-term goals, like buying home, paying for college or planning for retirement. If you’re eligible for a 401(k) match, start investing now, to take advantage of their matching contribution.
