Saving and investing are terms that are frequently used interchangeably, but to the surprise of some, they are not the same thing. Both are vital concepts for sound financial planning, but it is important to understand the differences.
Saving means setting aside money for future use, rather than spending it immediately. Saving usually means putting money into a bank’s deposit account. Ideally, you do not want to use money from this account until you reach the target amount required to achieve your goal.
Investing, on the other hand, means using a portion of your money, with the intention to earn more money. This typically involves buying assets such as stocks, bonds or investing in a mutual fund. The objective of investing is to increase the value of your assets over time.
Risk and Return
Saving is generally considered a low-risk activity and therefore the return from saving is relatively low when compared to investing. Because returns are low, you tend to lose your purchasing power over time as inflation erodes the value of your money. Unless your savings increase faster than the rate of inflation, your savings will be effectively less valuable in the future than they are now.
When it comes to investing, however, investors should be aware that the potential for loss may be higher when compared to saving. Investing may be considered a higher risk activity since there is the potential for your investment to lose some or all its value
Time Horizon
Saving is typically pursued to achieve goals in the near future, such as purchasing a car, paying off for a home, or an emergency fund for a rainy day.
Investing is mainly used for long term goals, such as funding a child’s education or planning for retirement. The stock market can move up and down in the short term but historically by staying invested, you can improve your chances of making a gain from investing in the long-term.
Accessibility
A savings account provides easy access to your money.
When you invest your money, it can take days to access your money compared to a savings account.
When to Save
Choosing between saving and investing depends on your financial position and objectives.
If you have not built up your emergency fund yet, you should do so before investing. A good rule of thumb is to set aside six months worth of expenses in an emergency fund. If you need the money within five years, a savings account will likely be the best option.
When to Invest
If you don’t need the money for at least five years and are willing to take some risk, investing your money may yield better returns than saving.
If you have an emergency fund set aside and don’t have high-interest debt, you can increase your wealth over time by investing your extra money. Investing is essential if you want to reach your long-term goals.
Saving and investing are two very different financial strategies. Understanding the difference between the two will help you manage your money better. Why? You will get a better sense of when it’s a good time to save money and when it’s a good time to invest.