When it comes to personal wealth, most people feel daunted choosing between saving and investing. But it shouldn't necessarily be "saving vs investing", and definitely not "saving = investing". They are both ingredients that play very different roles within your financial goals’ recipe. Here's how and when you can use them to achieve your goals.
"Saving" and "Investing" are two of the most common terms in the context of personal finance nowadays. Acquiring an understanding of these financial principles is essential, not only for your financial literacy, but mainly for safeguarding your financial future. It becomes increasingly important as we deal with the increasing complexity of contemporary finance.
As we are currently standing at the crossroads of economic and political uncertainties, favoring shifting market sentiments and altering financial landscapes, it might be more important than ever to have an educated plan to secure our financial future. In this article, we will demystify the concepts of saving and investing by examining what each means, their similarities, and most importantly, their distinctions as well as how and when to choose each option.
Saving vs Investing – Key Takeaways
- Saving and investing are both essential elements of one's personal finances and it is likely that you will need both to reach your financial objectives.
- Saving refers to keeping money in a safe and liquid vehicle, with very little risk and smaller, but predictable returns.
- Investing is about putting your money into riskier vehicles, purchasing securities with a higher potential return, but also coming with higher risk and expecting that your money will grow over time.
- The way you approach each depends on your goals, risk tolerance and time horizon. At the end of the day, you should choose the best option for you.
What is Saving?
Saving money means putting aside part of your income for later use as opposed to spending it. You can make recurring or one-time contributions to increase your savings. Additionally, you can choose an easy-access saving account to withdraw the original deposit amount as well as any interest you may have accrued.
Saving might be a good option when you have short-term or immediate expenses that you can't afford to pay for on top of your regular monthly expenses. If you need the money sooner than five to seven years that a typical market cycle lasts, it's a good idea to deposit it in a savings account. If you intend to pay for the objective entirely out of your own pocket and don't need to rely on your money increasing much, saving might also be smart move. Building up savings for certain costs can take some time, but by doing so, you can avoid taking on high-interest debt because you will always have money set aside.
However, saving is not completely risk-free. Interest rates are subject to fluctuation. You will receive a very poor return on your savings while interest rates are low. There's a chance it won't outpace inflation, which is the rate of rise in prices for goods and services. Therefore, over time, the money in your savings account will lose purchase value even though it is still there. Simply put, you will buy less with the same amount of money.
When to Save Money?
Saving might be the higher priority withing the following scenarios:
- If you need the funds within the next five years, a money market fund or high-yield savings account would probably be your best option.
- Prior to starting investing, you should make sure you have enough money saved for emergencies. Most experts advise setting away at least three to six months' worth of spending in an emergency fund.
- It's advisable to primarily focus on saving if you have high-interest debt, such as credit card balances.
How to Save Money
While equities and other higher-risk assets may yield higher returns for investors, the purpose of saving is to keep some money liquid and grow slowly with little to no risk involved. If you are a saver, here are the top 4 places to consider for keeping your savings.
High-Yield Savings Accounts
High-yield savings accounts are a viable option as they offer a higher interest rate than a standard savings account. There can be restrictions on account access and a higher initial deposit needed. This kind of account is available to many banks and internet companies for their esteemed clients who already have accounts.
Certificates of Deposit (CDs)
A certificate of deposit (CD) is like a savings account, but typically offers a greater interest rate, particularly for larger and longer-term deposits.
However, there is a big difference between these two: you will have to keep the funds in the CD for a predetermined period; otherwise, there will be a penalty.Money Market Funds
This could be a great option if you're looking for a safe place to keep additional money that frequently yields higher interest rates than a regular savings account.
Also, if you don't want to keep your money in a CD for an extended period, a money market account may be a suitable substitute. If you want to avoid monthly maintenance costs or to start a money market account, you need to know that there are typically minimum deposit requirements.Treasuries & Bonds
If you want to keep your money in one place for at least five years, you may consider these options that are rather investing vehicles than saving. However, as they are usually carrying a much lower risk, savers see them as viable options as well. Treasuries and short-term bonds are issued by companies, municipalities, states, and governments to fund projects. There are differences between each type in terms of yields, maturity periods, and risk levels.
What is Investing?
Investing is also a way of setting aside money for the future, but in this case you expect them to grow (typically more than you could earn with a savings account over the long term) by placing in financial instruments such as stocks, bonds, or mutual funds.
Investing is frequently a wise move towards reaching long-term financial objectives. You may tolerate a fluctuation in the value of your investments when you don't need the money right away. Or, if you need to make much more money than you could save, investing can be a cleverer strategy.
But there is the other side of the coin that you should never forget about. Investing exposes you to market risk, which is a different kind of risk than the one associated with saving. Your investment's value may, and will fluctuate, which means you might receive less than you initially invested.
When the economy is expanding, financial markets are performing well, or companies’ profits are rising, investments may increase in value. Nevertheless, investors may also lose money in a bear market or during a period of poor business performance. Choosing assets with low risks is an option, but those typically come with lower returns.
When to Invest Money?
You may consider investing in one of the following scenarios:
- Investing will probably generate larger returns than saving if you can wait at least five years (or longer) and you are prepared to take some risks.
- You have paid off any high-interest debt and have established an emergency fund, but you want to build your wealth over time.
- You want to achieve long-term goals like retirement, down pay for a house you plan to buy in 10-15 years or leaving a financial legacy for your family.
How to Invest Money
One of the main reasons some people avoid investing is because many of them are unsure of how to invest money and where. While with savings the number of options is somehow limited, the array of securities in which people could invest is quite wide. Four of the most common investment options nowadays include:
Stocks
Over nearly every 10-year period in the last century, stocks have outpaced most investment classes and have historically yielded average annual returns of 9% to 10%.
Additionally, certain companies pay dividends, which can make them good choices for investors seeking to generate income from their portfolio or take advantage of compounding effect. However, the potential for higher returns comes along with higher risks.Funds
You can invest in mutual funds and/or exchange-traded funds (ETFs) if you're concerned about evaluating and picking specific stocks. Maybe that’s why funds are one of the most popular ways to invest money today.
Funds are pooled instruments, actively or passively managed, that enable investors to invest in a variety of assets, such as stocks, bonds, preferred shares, commodities etc.REITs
Owning real estate may be a fantastic way to accumulate wealth, just like owning successful businesses. However, buying and owning properties is not for everyone.
Trusts are another type of pooled investment. Real Estate Investment Trusts (REITs) are one of the most popular in this category. REITs invest in commercial or residential properties and pay regular dividends to their investors from the rental income received from these properties. REITs trade on stock exchanges and thus offer their investors the advantage of instant liquidity.Crypto
Cryptocurrencies are a relatively new form of investment vehicle. They can be included in a varied investing portfolio if you are familiar with them.
Cryptocurrency investors can buy or sell them directly in a spot market, or they can invest indirectly in a futures market or by using investment products that provide cryptocurrency exposure. They can even get exposure through the recently approved spot Bitcoin ETFs. This means that the performance of a Spot Bitcoin ETF is directly linked to the real-time value of the Bitcoins it holds.
What Are the Main Differences between Saving and Investing
Have a look at this brief comparison before making a choice in terms of saving vs investing:
Saving
Investing
Purpose
Suitable for short-term. Usually immediate objectives, such as emergency savings, car down payment, vacation budget or home improvement projects. Suitable for longer-term goals. Reaching long-term objectives like saving for retirement, child's education, starting a business or building wealth.
LiquidityImmediate access to cash. A savings account allows you to withdraw your money when you need it. Harder to access your funds. When you invest, it could take longer to access your money, depending on the type of investment.
RiskLower risk. By definition, saving entails very little risk. However, you can lose some buying power over time withing high inflation cycles. Always involves risk. Return is not guaranteed, Investing can always involve losing money when the market declines or a company’s performance slumps.
ReturnPredictable, but low returns. While money in a savings account might earn interest, it typically yields lower returns than investments. Potential higher returns. Investments typically have the potential for higher return but come along with higher risks.
Impact of inflationHigh exposure. Savings may not grow as quickly as inflation, thus reducing the purchase value of saved funds. Can beat inflation. Investing could generate returns that beat inflation, making it a viable hedge against rising expenses.
VehiclesLimited options. Saving is often done through deposit accounts like savings accounts or certificate of deposit (CD) accounts. Wide range of vehicles. Investing involves an array of investment vehicles, including stocks, bonds, ETFs, REITs, mutual funds, and others.
Why is Investing a More Powerful Tool to Build Long-Term Wealth than Saving?
Saving money is essential, no doubt. And this is because, most of the time, one cannot invest if he doesn't save first. However, it might not be enough if you want to reach your financial freedom.
Statistics don’t lie. Investing in the long-term may have several advantages. By maintaining composure and implementing a long-term investing strategy, it is possible to turn even the tiniest funds into a respectable amount of money. The power of compounding and the risk-return ratio are the main two reasons why investing is a more powerful tool to build long-term wealth than saving.
The Power of Compounding
The Risk-Return Ratio
When an investment yields income or dividends that are subsequently reinvested, this is known as compounding. Subsequently, these profits or dividends may produce additional profits. Put otherwise, compounding is the process by which your investments produce returns on their initial investment. For instance, if you purchase a dividend-paying stocks, you could think about reinvesting the dividends to benefit from the compounding effect. Invest as soon as you can and set up your dividends and other payments to be reinvested automatically to help maximize the potential benefits of compounding.
The risk represents the possibility that an investment will underperform or possibly lose value.
The return is the amount of money you potentially receive as result of your investments' overall value growth.
For instance, stock investments can yield larger profits.
While they are thought to be less risky stocks, a saving accounts probably won't offer the same potential for return.
The level of risk you take on is determined by your tolerance and is entirely up to you. However, if you want to beat inflation, taking on some risk might be inevitable.
Moreover, certain investments, such as stocks that pay high dividends and real estate investment trusts (REITs), can provide you with passive income streams. These investments may give you flexibility and financial stability by enabling you to generate money on a regular basis without participating actively. You can mitigate risks and increase possible rewards on your investments by diversifying your portfolio across different assets.
Saving vs Investing Pros and Cons
Although saving is undoubtedly safer than investing, it is unlikely to result in a significant growth in wealth over time. However, before starting to invest or save money, you should carefully assess your risk appetite, your goals and your time horizon.
Saving
Investing
Pros Cons Pros Cons Ideal for short-term goals Doesn’t create wealth Ideal for long term-goals Involves market risks
High liquidity Exposed to inflation May beat inflation over the long run Some vehicles may involve poor liquidity Earning interest Lower returns Can create wealth Investing can be complex
Should I Save or Invest in 2024?
Many individuals are searching for methods to allocate more funds to their investments and savings during periods when inflation is an issue, and the likelihood of a recession is high. Raising your income and reducing your expenses are the main ways you can do this.
It's normal to waver between investing and saving money. While investing has its own set of advantages, so does saving. Most people choose a balanced financial strategy that incorporates both investing and saving. For example, you could put money aside in a savings account for your summer vacation or your annual property taxes. Simultaneously, you may invest funds set aside for retirement and a potential business venture.
While your investments can shield your purchasing power from inflation, your savings buffer will protect you from potential near-term uncertainties
Check the following tips to strike a balance between investing and saving:
Conclusion
Saving and investing are both ways of setting money aside for the future. Both entail increasing your wealth, but with different levels of risk involved. While saving may sound easier, it comes along with lower returns and inflation exposure. On the other side, investing involves a higher degree of risk and knowledge, but potential returns may pay out.
For people who have short-term financial goals, a limited risk tolerance, or who require an emergency fund, saving is typically a better option. If you have a higher risk tolerance, are focused on long-term financial goals, and already have a rainy-day fund, investing might be your best option. Before choosing between saving and investing, or both, make sure you carefully assess your goals, risk appetite and time horizon.
Free resources
Before deciding to start saving and investing, you should consider using the educational resources we offer like CAPEX Academy or a demo trading account. CAPEX Academy has lots of free trading courses for you to choose from, and they all tackle a different financial concept or process – like the basics of analyses – to help you to become a better trader or make more-informed investment decisions.
Our demo account is a suitable place for you to get an intimate understanding of how trading and investing work – as well as what it’s like to trade with leverage – before risking real capital. For this reason, a demo account with us is a great tool for investors who are looking to make a transition to leveraged securities.
Sources:
https://www.fca.org.uk/investsmart/should-you-invest
https://www.sec.gov/investor/pubs/sec-guide-to-savings-and-investing.pdf
https://moneysmart.gov.au/how-to-invest