Saving and investing are both important for building a sound financial future, but they are not the same thing. Saving typically results in lower returns but with little to no risk, while investing allows for higher returns, but with the risk of loss. Saving is best for immediate or near-term expenses, while investing is better for long-term goals.
Characteristics | Values |
---|---|
Risk | Saving typically results in a lower return but with virtually no risk. In contrast, investing allows the opportunity to earn a higher return but with the risk of loss. |
Assets | Saving involves putting money in bank products such as savings accounts, money markets and CDs. Investing involves putting money in stocks, ETFs, bonds and mutual funds. |
Time horizon | Saving is good for short-term needs. Investing is good for long-term goals. |
Access | With saving, you have immediate access to your money. With investing, there may be barriers and penalties for withdrawing investment gains early. |
Returns | Returns on savings accounts are predictable and usually only fluctuate if the federal reserve increases or decreases interest rates. Returns on investments are unpredictable and fluctuate with the market. |
What You'll Learn
Savings accounts are a good vehicle for those who need to access cash in the near future
Savings accounts are a good option for those who want to avoid the risk of investing. While investing can yield higher returns, it also comes with the risk of losing money. If you need to access your money soon, investing may not be the best option, as you may need to wait for the market to recover from a downturn.
Savings accounts are also a good choice for those who want immediate access to their money. While some investment accounts may charge penalties or taxes for early withdrawals, savings accounts typically allow you to withdraw your money at any time without penalty.
In addition, savings accounts are a good option for those who want to avoid the fees and minimum balance requirements that may be associated with investment accounts. Many savings accounts have no fees or minimum balance requirements, making them accessible to a wide range of people.
Overall, savings accounts are a good choice for those who want a safe, flexible, and accessible place to store their money in the short term. While investing may be a better option for long-term goals, savings accounts are ideal for those who need to access their cash in the near future.
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Investing is for growing your money
While saving and investing are often lumped together, they are distinct strategies for achieving different financial goals. Saving is for preserving your money, while investing is for growing it.
How investing grows your money
When you save money in a bank account or CD, you earn a steady amount of interest, and your principal remains intact. When you invest, your returns can fluctuate from day to day.
Investing can provide you with another source of income, fund your retirement, or even get you out of a financial jam. It grows your wealth, helping you meet your financial goals and increasing your purchasing power over time.
Types of investments
There are many ways to invest, from safe choices such as CDs and money market accounts to medium-risk options such as corporate bonds, and even higher-risk picks such as stock index funds.
- Long-term certificates of deposit (CDs): CDs are issued by banks and offer a higher interest rate than savings accounts. They are a good choice for retirees who don't need immediate income and can lock up their money for a fixed term.
- Long-term corporate bond funds: Corporate bond funds can provide cash flow for retirees or those who want to reduce their portfolio risk while earning a return.
- Dividend stock funds: Dividend stocks pay out a portion of a company's profits to shareholders, usually quarterly. Dividend stock funds are a good selection for investors looking for income.
- Value stock funds: These funds invest in value stocks, which are more bargain-priced than others in the market. They tend to do better as interest rates rise.
- Small-cap stock funds: These funds invest in stocks of relatively small companies, which often have strong growth prospects.
- Real estate investment trusts (REITs): A REIT is a way to invest in real estate by purchasing shares of a company that owns and manages properties. REITs pay out dividends in exchange for not being taxed at the corporate level.
- S&P 500 index funds: An S&P 500 index fund is based on about 500 of the largest American companies, such as Amazon and Berkshire Hathaway. It provides broad, diversified exposure to the stock market and has returned about 10% annually.
- Nasdaq-100 index funds: An index fund based on the Nasdaq-100 gives investors exposure to some of the biggest and best tech companies, such as Apple and Alphabet.
When to invest
Investing is generally recommended for long-term goals that are at least three to five years away, as it gives your investments time to recover from any short-term losses.
Additionally, if you have an employer-matched retirement plan, such as a 401(k), it is advisable to contribute at least enough to get the full match, as this is essentially free money.
Factors to consider before investing
When deciding whether to save or invest, it is crucial to determine when you will need the money. Here are some factors to consider:
- Risk tolerance: How much risk are you comfortable with? Conservative investors or those nearing retirement may prefer less risky investments, such as savings accounts or CDs.
- Time horizon: Do you need the money in the short term or long term? If you have a shorter time horizon, safer investments like savings accounts or CDs are more appropriate.
- Knowledge of investing: Some investments, like savings accounts, require little knowledge. However, market-based products like stocks and bonds require more understanding of the company, industry, finances, etc.
- Amount to invest: If you have a larger amount to invest, it may be worth the time to research specific stocks or industries. Otherwise, you may stick with less time-intensive options like ETFs or mutual funds.
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Savings accounts are good for short-term needs
- Safety and accessibility: Savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC) at banks and by the National Credit Union Administration (NCUA) at credit unions, so your money is protected. Savings accounts also offer immediate access to your money, as transferring money into and out of your savings account is as easy as logging in to your bank's website or walking into a bank branch.
- Minimal risk: Savings account balances have no risk of declining. The Federal Reserve increasing or decreasing interest rates are usually the only factors that cause yields on savings accounts to fluctuate.
- Predictable returns: Yields on savings accounts usually only fluctuate if the federal reserve increases or decreases interest rates, which happen at set intervals throughout the year.
- No barriers to access: While investment accounts may charge penalties or taxes, or both, for withdrawing investment gains early, there are no such barriers with savings accounts.
- Good interest rates: While savings accounts may not offer the same high returns as investment accounts, they still allow you to earn interest on your money.
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Investing is good for long-term goals
Investing is a great way to grow your money over the long term, making it a strong option for funding expensive future goals like retirement. While saving is safer than investing, it will likely not result in the most wealth accumulated over time. Here are some reasons why investing is good for long-term goals:
- Investing products such as stocks can have much higher returns than savings accounts and CDs. Over time, the Standard & Poor's 500 stock index (S&P 500) has returned about 10% annually, though returns can fluctuate greatly in any given year.
- Investing products are generally very liquid. Stocks, bonds, and ETFs can easily be converted into cash on almost any weekday.
- If you own a broadly diversified collection of stocks, you are likely to beat inflation over long periods and increase your purchasing power. The target inflation rate used by the Federal Reserve is currently 2%, but it has been much higher in the past two years. If your return is below the inflation rate, you will lose purchasing power over time.
- Investing can help you grow your money over the long term, making it a strong option for funding expensive future goals such as retirement, building generational wealth, or generating income.
- By investing in stocks and stock funds, you can enjoy potentially much higher returns than with a savings account, and do it all tax-free if you use a Roth IRA.
It's important to note that investing carries more risk than saving, as there is always the possibility of losing some or all of your investment capital. However, with proper research and a long-term perspective, investing can be a great way to achieve your financial goals.
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Savings accounts are for preserving your money
Savings accounts also offer liquidity, which means you can easily withdraw your money whenever you need it. You can withdraw cash from an ATM or transfer funds online. This ease of access makes savings accounts a popular choice for people who need quick access to their funds.
Another benefit of savings accounts is that they are low-risk. Unlike investment options such as stocks or mutual funds, savings accounts carry a very low risk. While the returns on savings accounts are typically lower than other investment options, the principal amount is safe and secure. You don't have to worry about the volatility of the stock market or the performance of a particular mutual fund. Savings accounts offer stability and security, making them ideal for risk-averse individuals.
Additionally, savings accounts offer interest on deposits. You can earn an attractive rate of interest on your savings, with the interest usually calculated on a daily or monthly basis and credited to your account at regular intervals. This means your money is not only safe but also earning some returns.
Overall, savings accounts are an excellent option for preserving your money. They offer security, liquidity, low risk, and some returns on your deposits. While they may not be the best option for those seeking higher returns, savings accounts are well-suited for those who prioritise safety and stability for their funds.
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Frequently asked questions
Saving is for preserving your money, while investing is for growing it. When you save money in a bank account or CD, you earn a steady amount of interest and keep your principal intact. When you invest, you could lose money, break even, or earn a return—there are no guarantees.
You should save money if you don't have an emergency fund or if you'll need the cash within the next few years.
You should invest money if you have a topped-up emergency fund and don't anticipate needing a lot of cash in the next few years. You should also invest if you're eligible for an employer match in your retirement account.
Some good savings accounts include high-yield savings accounts, money market accounts, CDs, treasury bills, and government bonds.