Many people use the terms saving and investing interchangeably because they go hand in hand to ensure financial stability. But saving and investing have many differences that you should know when planning for your financial future. In general, saving provides a safety net for unexpected expenses and short-term spending goals, while investing is a strategy to help build long-term wealth. Being aware of these differences can help you prepare the best financial foundation for yourself and your family.
The main difference between saving and investing is the amount of risk you are willing to take to reach financial goals.
When saving, you generally want a low-risk option to build and maintain wealth. Saving is when you gradually set aside funds — maybe a portion of your paycheck — in a safe place, like a savings account or money market account. These accounts allow you to store cash that can be easily accessible and have little risk of loss of value. Saving is often intended to reach shorter-term financial goals, like creating a fund for emergencies or saving a house down payment.
Investing is when you put money at risk to make more money. When investing, you may trade stocks, mutual funds, or other assets because there’s a potential for a return on the investment, but you are also at risk of losing the value of the investment. The goal of investing is to grow your wealth over time by taking advantage of capital appreciation and compound interest. This strategy is typically used to reach long-term goals, like building wealth for retirement or saving for a child’s college fund.
Saving and investing is not an either/or proposition. Generally, saving and investing go hand in hand to ensure financial stability. However, certain scenarios make one strategy better than the other.
Building up emergency savings is one of the first things to do before you start investing. An emergency fund would ideally help you following an unexpected financial event, like paying a hefty medical bill or covering expenses if you were to lose your job. It is recommended that you save the equivalent of three to six months of expenses and debt payments in an emergency savings fund.
If you need money for short-term goals, like a down payment on a house or an upcoming vacation, you should choose to save. A high-yield savings account or a money market account may be the best option to save for these short-term goals.
Savings accounts are highly liquid, meaning that you can access the money in your account as soon as possible. You can go to your bank, withdraw funds from a savings account, and have the cash right away.
Here are some tips for deciding when you should decide to invest.
Paying off high-interest debt, such as a credit card balance, will likely provide you with a sound financial foundation. You’re paying off an interest rate that’s likely higher than potential investment returns. Once you pay off high-interest debt, you can look to invest money in stocks, bonds, and other assets.
There is potential for greater rewards when you invest because of a capital appreciation and compound interest. But when you invest, there is no guaranteed return on your investment, and you can lose part or all of the funds. This risk-reward calculation is best for long-term goals, because you can withstand the volatility of the financial markets. This strategy is best for building a retirement nest egg or savings for a child’s college tuition.
Contributing to an employer-sponsored 401(k) or an Individual Retirement Account (IRA) should be your first step in building wealth for retirement. These retirement accounts provide tax-advantaged ways to invest your money. Once you’ve maxed out contributions to these accounts, it may be good to explore additional investment products.
- FDIC Insurance: You want to make sure the Federal Deposit Insurance Corporation (FDIC) insures your savings accounts. The FDIC guarantees up to $250,000 in nearly all savings account products if your bank fails.
- Interest Rate/APY: Many traditional banks pay little interest on savings account deposits, so you may want to shop around to see where you can get the best rate. Certain institutions offer higher interest rates than large, brick-and-mortar banks.
- Fees: You want to look for savings accounts with little or no fees. Many banks may waive fees if you have a large enough balance or enroll in direct deposit, while other institutions won’t charge a fee no matter what.
- Diverse investment options: You want to ensure your brokerage firm offers a wide range of investment products, including stocks, bonds, options, ETFs, and mutual funds. Additionally, brokerage firms that provide individual retirement accounts (IRA) may be ideal if you’re looking to save for retirement.
- Commissions/Fees: High commissions and fees can eat away at your investments, so you want to look for brokerage firms with low investment fees.
- Account Minimums: Many brokers require that a customer deposit a minimum amount to open an account. Depending on your financial situation, you may want to look for a brokerage account with an account minimum that you can afford without straining your finances.
Another thing to consider when deciding between saving and investing is how inflation affects your money with each strategy. With investing, there is a potential for your investments to keep up with inflation, which may be ideal in a high inflation environment. In contrast, inflation may eat away at your savings because the money you put into your account today will be worth less a year from now.
Nonetheless, no one strategy works for everyone because financial situations differ, as do financial goals and comfort with risk levels. The real question isn’t whether you should save or invest; it’s more about how to include a combination of both to meet your financial goals.
This article originally appeared on SoFi.com.
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