Saving and investing are important concepts in building a solid financial base, but they are not the same thing. While both can help you achieve a more comfortable financial future, consumers need to understand the difference and know when is the best time to save and when to invest.
The biggest difference between saving and investing is the risk it takes. Saving usually results in lower returns, but there are practically no risks. On the other hand, investing allows you to get a higher return, but you risk losing it.
Here are the main differences between the two – and why you need both strategies for long-term wealth building.
Stating savings versus investment
Saving is the act of raising money for future expenses or needs. If you decide to save, you want the money to be available relatively quickly, maybe use it right away. However, savings can also be used for long-term goals, especially if you want to ensure that you have the money at the right time in the future.
Depositors usually deposit funds into low-risk bank accounts. Those looking to maximize their profits should choose the highest annual savings account (APY) they can find (provided they meet the minimum balance requirements).
Investing is similar to saving because you are saving for the future, except that if you take more risks, you want to get a higher return. Typical investments are stocks, bonds, mutual funds, and exchange-traded funds (ETFs). You use an investment brokerage or brokerage account to buy and sell them.
If you want to invest money, you need to plan to keep your money in investing for at least five years. Investments can be very volatile for a short time and you can lose money from them. Therefore, it’s important to only invest money you don’t need right away, especially in a year or two.
The table below summarizes some of the key differences between saving and investing:
|Return||Relatively low||Potentially higher or lower|
|Risk||Virtually none on FDIC-insured||Varies by investment, but there is always the possibility of losing some or all of your investment capital|
|Typical products||Savings accounts, CDs, money-market accounts||Stocks, bonds, mutual funds, and ETFs|
|Time horizon||Short||Long, 5 years or more|
|Protection against inflation||Only a little||Potentially a lot|
|Expensive?||No||Could be, depending on how much your buy and trade and realize taxable gains|
|Liquidity||High, unless CDs||High, though you may not get the exact amount you put into the investment depending on when you cash in|
How are saving and investment similar?
As you can see in the table above, saving and investing have many different functions, but they both have one common goal: they are both strategies you can use to make money.
“It’s both primarily about raising money for future reasons,” said Chris Hogan, a finance expert at Ramsey Solutions and author of Retire Inspired.
Both use special accounts with financial institutions to raise funds. For savers, this means opening an account at a bank such as Citibank or a credit union. For investors, this means opening an account with an independent brokerage, although many banks now also have brokerage arms. Popular investment brokers include Charles Schwab, Fidelity, and TD Ameritrade, as well as online options such as E * Trade.
Both savers and investors alike recognize the importance of saving. Investors must have sufficient funds in their bank accounts to cover emergencies and other unforeseen expenses before they can make any changes to long-term investment.
As Hogan explains, investing is money that you want to leave “so that it can grow for your dreams and future.”
What is the difference between saving and investing?
“When you use the word save and invest, people – 90 percent of people actually – think it’s the same thing,” said Dan Keedy, CFP and chief financial planning strategist at TIAA, a financial services organization.
Although the two endeavors have some similarities, saving and investing are different in many ways. And it starts with the asset type on each account.
When saving, consider banking products such as savings accounts, money markets, and CDs – or certificates of deposit. And when you think about investing, think about stocks, ETFs, bonds, and mutual funds, says Kiddie.
The pros and cons of saving money
There are many reasons to save your hard-earned money. On the one hand, this is usually your safest bet and the best way to avoid losing money along the way. It’s also easy to do, and you have instant access to funds when you need them.
All in all, saving comes with these benefits:
- Savings accounts tell you upfront how much interest you’ll earn on your balance.
- The Federal Deposit Insurance Corporation guarantees bank accounts up to $250,000, so while the returns are lower, you’re not going to lose any money when using a savings account.
- Bank products are generally very liquid, meaning you can get your money as soon as you need it, though you may incur a penalty if you want to access a CD before its maturity date.
- There are minimal fees. Maintenance fees or Regulation D violation fees (when more than six certain transactions are made out of a savings account) are the only way a savings account at an FDIC-insured bank can lose value.
- Saving is generally straightforward and easy to do. There usually isn’t any upfront cost or learning curve.
Despite its perks, saving does have some drawbacks, including:
- Returns are low, meaning you could earn more by investing (but there’s no guarantee you will.)
- Because returns are low, you may lose purchasing power over time, as inflation eats away at your money.
The pros and cons of investing
Saving is safer than investing, though it will likely not result in the most wealth accumulated over the long run.
Here are just a few of the benefits that investing your cash comes with:
- 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 percent annually, though the return 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, then you’re likely to easily beat inflation over long periods and increase your purchasing power. Currently, the target inflation rate that the Federal Reserve uses is 2%. If your return is below the inflation rate, you’re losing purchasing power over time.
While there’s the potential for higher returns, investing has quite a few drawbacks, including:
- Returns are not guaranteed, and there’s a good chance you will lose money at least in the short term as the value of your assets fluctuates.
- Depending on when you sell and the health of the overall economy, you may not get back what you initially invested.
- You’ll want to let your money stay in an investment account for at least five years so that you can hopefully ride out any short-term downdrafts. In general, you’ll want to hold your investments as long as possible — and that means not accessing them.
- Because investing can be complex, you’ll probably need some expert help doing it — unless you have the time and skillset to teach yourself how.
- Fees can be higher in brokerage accounts. You’ll often have to pay to trade a stock or fund, though some brokers offer free trades. And you may need to pay an expert to manage your money.
So which is better – saving or investing?
Neither saving or investing is better in all circumstances, and the right choice depends on your current financial position.
Generally, though, you’ll want to follow these two rules of thumb:
- If you need the money within a year or so or you want to use the funds as an emergency fund, a savings account or CD is your best bet.
- If you don’t need the money for the next five years or more and can withstand some losses in capital, then you likely should invest the money.
Real-world examples are the best way to illustrate this point, says Keady. For example, if you pay your child’s tuition fees in just a few months, you’ll need to save – a savings account, money market account, or short-term CD (or CD that expires when needed).
“Otherwise people will say, ‘Yeah, you know, I have a year and I’m buying a house or something, maybe I should invest in the stock market,'” said Keady. “Now it’s playing rather than saving.”
The same applies to emergency funds, which should not be invested but kept in savings.
“So if you get sick, lose your job, or whatever, you don’t have to go into debt,” said Hogan. “You have money that you deliberately set aside to be a pillow between you and life.”
And when is it better to invest?
Investing is better for long-term money – money that you want to grow more aggressively on. Depending on the level of risk tolerance, investing in the stock market, in exchange-traded mutual funds, or mutual funds can be an option for someone who wants to invest.
If you can hold on to your investment money any longer, you will give yourself more time to get out of the inevitable highs and lows of financial markets. So investing is a good option if you have a long horizon (ideally many years) and shortly, you do not need access to money.
“So when someone starts investing, I would encourage them to see growth mutual funds as a great entry point for startups,” said Hogan. “And you’re starting to understand what’s going on and how money can grow.”
While investing can be tricky, there are easy ways to get started. The first step is to learn more about investing and why it could be the right step for your financial future.