There are some key differences between saving and investing, but they can also be done at the same time. Which means, you don’t have to choose one or the other.
While saving can help you reach shorter-term goals (planning for a vacation) and even some longer-term goals (buying a house), it’s generally considered a good approach if your financial goal can be reached in 5 years or less. The money you put into a savings account is more liquid than the money you put into investments.
Investing, on the other hand, may help you reach even longer-term goals, such as retirement, or a college fund for your future children or grandchildren. You also get the opportunity to compound, which occurs when you reinvest the investment’s earnings to potentially generate more earnings.
When it comes to investing, patience is key. Some types of investments may need more time to mature and, there could be costs or penalty fees associated with selling or removing money from investments before they come to term. Others are more marketable, but you may not want to sell during a market downturn.
Saving is the lower-risk, lower-return option. Saving can come in the form of a certificate of deposit (CD), money market account or a more traditional bank savings account.
If you deposit money and leave it in a savings account, it will accrue additional value over time, although typically at a lower rate than what investments have the potential to provide. You agree to let the bank keep your money for a while (sometimes a set amount of time, as with a CD; sometimes indefinitely, as with a savings account). In turn, the bank gives you a percentage of interest on that cash.
In general, it’s recommended that you begin building savings before you dive into investing, especially as protection against unexpected costs. Forty percent of U.S. adults say they couldn’t cover an unexpected expense greater than $400 without selling something or borrowing money.1 Anything from replacing a laptop to suddenly being out of work could put you in danger of not being able to afford monthly payments like your rent, mortgage, or car payment.
The rule of thumb is to have at least six months' worth of your household income set aside in your emergency fund. If six months sounds intimidating, start with three months and grow your savings from there.
There are many types of investments: stocks/bonds/mutual funds/ETFs and real estate are a few examples. While you can buy and sell these assets at any time, it’s better to approach them as long-term investments to get the best potential for growth.
A good way to start investing is through a retirement account. This could be a 401(k), an IRA or both. If you have access to an employer-sponsored 401(k), check to see if they offer contribution matches. This means that for every dollar you contribute to your 401(k), your employer contributes a certain amount, too—usually up to a specific limit.
IRAs, or individual retirement accounts, are a good option if you don't have access to a 401(k). IRAs are set up through a financial institution and most people are eligible to open and contribute to a traditional or Roth IRA. There are even options for individuals who are self-employed or small business owners.
Retirement accounts are typically made up of a mix of investment types such as stocks, bonds and mutual funds. You can either set up your own ratio of these investment types, or choose a target date fund, which is an investment mix that’s optimized for your anticipated retirement date.
For example, if you’re close to retirement, your investment mix will often include lower-risk assets, whereas the farther away you are from retirement, the more risk you may be able to shoulder because you’ll have more time to bounce back from any market volatility.
A healthy financial future involves both saving for goals in the short-term and investing for long-term growth. Whatever your financial situation, start thinking about both options today as you plan for tomorrow.
Learn more about fitting investing into your life with our guide to investing.