Should You Save Your Money or Invest It?

Whether you have an established financial plan or you’re just beginning to consider how to put your money to work, you should keep in mind the differences between saving and investing. These terms are often used interchangeably, but they represent different approaches to your personal finances. 

You’ll want to consider both saving and investing at different points in your life, but the key is to understand the pros and cons of each, and how they fit into the bigger picture of your financial journey.

Key Takeaways

• Understanding the purpose of saving and investing helps in making informed financial decisions.
• Factors such as time horizon, risk tolerance, and financial goals may influence your choice to save or invest.
• Saving offers low risk and quick access to funds, while investing provides the potential for higher returns and wealth growth.
• Determining the right approach requires evaluation of your personal financial situation, goals, and comfort with saving and investing.

Understanding Saving and Investing

Saving refers to setting aside cash in a low-risk, low-return environment. This could include traditional or online savings accounts at banks, money market accounts, certificates of deposit (CDs), or even a situation in which you hold onto cash outside of a financial institution.

Money held in one of these settings is more liquid than money in most types of investments, meaning you can access it more quickly and easily if necessary for emergencies or short-term goals. However, in exchange for carrying a lower level of risk than investments, these methods of saving money also provide less of a reward: in this case, they offer lower rates of return.

Investing your money means buying any of several different investment vehicles that carry a higher risk and, potentially, a higher reward. Investments may include stocks, bonds, exchange-traded funds (ETFs), commodities, real estate, and more.

Important

Not all investment vehicles carry the same levels of risk and reward. Some, such as bonds, may require months or even years before reaching maturity.

Similarly, there are many different ways to access investments, including through retirement accounts, mutual funds, individual stock trading, and more. Regardless of the type of investment or its particular risk and reward profile, however, the goal of all investments is the same: to grow your wealth over the long term.

Factors To Consider When Deciding To Save or Invest

Both saving and investing involve setting aside money now for a future goal or expense. However, the time horizon, level of risk, and most pertinent financial goals vary depending on whether you are looking at saving or investing your money.

Taking a close look at each of these factors can help you determine what to prioritize:

Time Horizon

One of the biggest considerations when deciding whether to save or invest is the time horizon of your financial goals. Some goals have a limited scope or a definite endpoint. In these cases, it may make the most sense to keep your money easily accessible in a savings account or similar vehicle, as you will not hold the money long enough for it to grow significantly in an investment setting. 

Bradley Baskir, Vice President and Financial Advisor at Morgan Stanley in Boston, says that saving is usually preferred “when the time horizon for liquidity is under 12 months.” He adds that saving for short-term goals by “depositing that pool of money in a savings account may make more sense than investing it because [you] can feel confident that the money will be there” when the goal arrives.

On the other hand, other financial goals may be more significant or more open-ended. If you’re planning for retirement, you are more likely thinking years or even decades ahead. Longer-term goals like these benefit from an investment-centered approach. The longer time horizon of these priorities means your money will have the opportunity to grow more significantly if it is invested, and you will not need it to be liquid until you get close to reaching the goal at some point farther in the future.

Risk Tolerance

Another key factor when deciding about saving or investing is your risk tolerance. Risk tolerance refers to the degree of risk that you are willing to take on given the potential volatility of a financial decision.

Saving your money is less risky than investing it. If you invest your money, you stand to potentially lose your principal, or initial investment.

Consider a situation in which you’re looking ahead to a longer-term financial goal. Given time horizon alone, you might be inclined to assume investing is the best approach. However, if you’re also facing uncertainty regarding your job stability, or there are ongoing periods of volatility in the market, or you’re otherwise unsure of what your financial situation will be, it may be safest to put your money in a savings account instead.

Note

Each person has a different risk tolerance, which is distinct from that person’s risk capacity, or capability to take on risk. Your risk tolerance may be dependent upon factors such as your age, your financial goals, and your income, among other factors.

Financial Goals

Laying out clear financial goals will help you to decide when it is appropriate to save or invest—or a combination of both. Financial goals may be large, such as preparing for a down payment on a home, a new vehicle, college tuition, or planning for retirement. They may also be more modest, such as saving for a small purchase or a short weekend trip.

The nature of your financial goals will influence your decision to save or invest. If your goal requires that you have quick access to cash, you’ll likely opt to hold money in a savings account or similarly liquid space.

On the other hand, if you’re hoping for better returns on your money than can be achieved with saving account interest rates and over a long period of time, investing may be the answer.

Many financial advisors recommend setting aside an emergency fund in a liquid account before considering investing.

Pros and Cons of Saving

Saving offers security but lower potential for rewards.  

Pros

• Saving your money entails a low level of risk.

• Some methods of saving are insured by the Federal Deposit Insurance Corporation or the National Credit Union Administration.

• Savings and similar accounts typically make it easy to access your funds.

• Ease of use; most of these accounts do not require regular upkeep or observation.

Cons

• Lower potential returns compared to investing.

• Potential for savings accounts to fail to keep up with inflation, eroding your purchasing power over medium- and long-term time horizons.

Pros and Cons of Investing

Likewise, investing offers both benefits and downsides. Baskir notes that “investing is by nature a trade-off between risk and return, so those who are willing to stay the course in a diversified portfolio, over long periods of time, in any market environment, should stand to be rewarded with returns that outperform that of cash equivalents earned from saving alone.”

Pros

• Investing provides the potential for (significantly) higher returns than saving. As your investments grow, they allow you to take advantage of compounding to accelerate gains.

• Investing offers many different access points and strategies, from individual stocks and bonds to mutual or exchange-traded funds.

• Investing your money allows you to buy into companies, industries, and sectors that interest you or that you support.

Cons

• In some cases, investments are less liquid than savings. It may take more time to access your funds, and it could potentially cost you money, as in the case of withdrawing early from retirement accounts.

• Markets for stocks, commodities, real estate, and other assets are often highly volatile, meaning that you may not achieve gains and may even lose some of your principal.

• Some approaches to investing are very hands-on and require both time and specialized knowledge.

• Investors are subject to biases and emotion-based decision-making which can adversely impact their investments.

Determining the Right Approach

Baskir says that “saving is to walking what investing is to running.” He adds that it’s vital to “have enough saved up for a rainy day, typically equal to three to six months worth of expenses in the event of a layoff, health issues,” or other unexpected changes to a financial situation before investing.

To determine the best approach for you, consider this checklist:

• Do you have an adequate cash cushion that would cover three to six months of fixed expenses? If not, then start saving.
• Do you have other short-term goals requiring quick access to cash (like travel plans)? If so, start saving.
• Are you on track to reach your retirement goals by your desired age? If not, start investing.
• Do you understand the risks involved in investing this money for a long-term goal such as retirement? You may not be able to access it until age 59½ without taxes and a penalty, plus you’ll face volatility risk, etc.
• Are you comfortable waiting to access your money in order to take advantage of compounding? If so, you may want to start investing.
• Do you feel comfortable with your current split of saving and investing every month? Where does it feel like you’re falling short?

Saving vs. Investing: Example

Let’s say that you are in your late ‘30s, single, and making a six-figure income. Currently, you have about two month’s expenses in savings and just over a year’s salary in your company-sponsored 401(k). You’ve also recently paid off your student loans and have $500 to reallocate to your other financial goals, which include:

• Boosting your emergency fund to cover at least three months of expenses.
• Increasing your retirement savings to ensure that you will be able to retire at age 67 with an income that covers your needs.
• Putting aside extra money for travel.

The amount that you decide to contribute to each category depends on your priorities. It’s also subject to change: for example, you might decide that in the short term, creating an emergency fund that covers three months of expenses is most important. Once that goal is funded, you can move on to putting more money toward retirement (and fun). 

When To Save

Saving may be the best option for you if you have yet to establish a rainy day fund if you have a short-term financial goal, if you expect to need access to your funds on short notice, or if your risk tolerance is low and you want to protect your principal.

Choosing a Savings Account

There are a variety of savings accounts available today, including traditional accounts, online-only accounts, high-yield accounts, money market funds, and more. Look to Investopedia’s in-depth guide for an overview of many of the most popular savings account options and suggestions on how to pick the right account for you.

When To Invest

Investing could be the choice for you if you already have an emergency fund and if you are planning for a long-term financial goal, if you’re seeking compounding interest on your funds, if you have the flexibility to hold your funds in a less accessible account, or if you have a higher tolerance for risk.

Choosing a Brokerage Account

Selecting a way to invest your money can be a much more complex question than selecting a savings account. Most beginning investors will use a brokerage account to facilitate trades. Many of the leading brokerages offer an easy-to-use interface, free trades in certain cases, and access to a variety of assets including stocks, mutual and exchange-traded funds, and more.

It pays to consider the ways you plan to invest—actively or passively, what types of asset classes you will target, and so on—and use Investopedia’s guide to select a broker.

What are the advantages of saving money instead of investing it?

Some of the advantages of saving over investing include a lower level of risk, easier access to your funds, and a comparably straightforward process.

What factors should be considered when deciding between saving and investing?

Keep in mind your financial goals—large or small, necessary or discretionary—and what the time horizons of those goals are. Your appetite for risk is also important. You can also allocate some funds to saving and some to investing in order to achieve both short- and long-term priorities.

Can saving and investing be done simultaneously?

Absolutely. Advisors recommend that individuals set aside an emergency fund of several months’ worth of expenses in a savings account or similarly liquid option before considering whether to invest additional funds. Further, you may consider saving for some types of financial goals while you also invest in an effort to achieve others.

The Bottom Line

Saving and investing are sometimes used interchangeably but they represent different ways of using your money. Saving refers to holding your funds in a low-risk, low-return savings account, CD, or money market account, while investing refers to buying and selling stocks, bonds, ETFs, mutual funds, commodities, and/or real estate.

Saving is generally seen as preferable for investors with short-term financial goals, a low risk tolerance, or those in need of an emergency fund. Investing may be the best option for people who already have a rainy day fund and are focused on longer-term financial goals or those who have a higher tolerance for risk.

Read the original article on Investopedia.