There are some key differences between saving and investing. Both strategies involve accumulating money for future use, but their level of risk is not equal. And how you determine when to save and when to invest will depend on your budget and financial goals.
Fortunately, you can do both at the same time, which means you don’t have to choose one or the other.
Saving is generally considered a good approach if your financial goal can be reached in five years or less, such as planning for a vacation or buying a house. The money you put into a savings account is more liquid than the money you put into investments.
Investing, on the other hand, can help you work toward reaching your longer-term goals, such as retirement or a college fund for your future children or grandchildren. When it comes to investing, patience is key. The longer your money is invested, the more potential it has to grow and earn compound interest, which occurs when you reinvest the investment’s earnings to potentially generate more earnings.
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 traditional bank savings account.
If you deposit money and leave it in a savings account, it will accrue interest 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 and pay off high-interest debt before you dive into investing, especially as protection against unexpected costs. The rule of thumb is to have at least three to six months' worth of your household income set aside in an emergency fund.
There are many types of investment vehicles: stocks/bonds/mutual funds/ETFs and real assets (such as real estate and commodities) are a few examples.
While you can buy and sell these assets at any time, 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, so 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.