Financial security can be attained via both investment and saving.
You must refrain from spending today in order to invest or save money for the future.
Whether you retain your remaining funds in cash or another type of asset makes a distinction between saving and investing.
Saving is the act of laying money aside for future needs. Investing is the act of utilising money to purchase other assets that you anticipate will bring in income or profit.
These additional assets are typically exchange-traded funds (ETFs), mutual funds, equities, and bonds. Other investable assets include real estate, cryptocurrencies, and artefacts from collections.
How saving and investing differentiate
Saving involves using money. You resist making purchases and retain your money in a savings account, a certificate of deposit (CD), or another location in your house.
It is intended to have those cash on hand for future usage.
You spend your cash to purchase another asset when you invest money. Making money or profits is the aim here.
Examples of investing include:
- When you buy stocks, you anticipate an increase. You can make money when you sell the stock when its value increases.
- buying dividend-paying stocks. The dividend income might be used to cover expenses or to purchase additional equities.
- Purchasing property that generates rental revenue. After paying your property expenses, the rents you earn should result in profits.
- purchasing shares of a mutual fund that invests in bonds. You can use the money, just like dividend payments, to pay bills or to purchase additional mutual fund shares. Compound interest works in your favour if you purchase more shares. This is when your interest begins to earn interest, which is a potent strategy to gradually amass riches.
When you should save
When you have a salary but little to no cash on hand, you should start saving. Make it a point to accumulate enough cash savings to last for six months’ worth of spending. This safeguards you from unanticipated financial crises like a car accident or job loss.
Saving is also advisable for achieving short-term financial objectives. A few examples are paying for a home, college, or a wedding. Saving is a better option than investing if you have five years or less to attain your objective.
Keep in mind that trying to save money can be difficult if you have high-interest debt. Some will contend that paying off debt before saving is preferable. However, it’s risky to live without an emergency fund. You would need to take out further loans to pay for any unexpected expenses. Save what you can while paying off debt to prevent that from happening.
New to investing and not sure where to start?
How to pick a savings account
- Is the interest rate competitive? Interest rates on savings accounts vary widely. Look for a high-yield savings account to help increase your money.
- Can you automatically transfer money from your checking account into the account?
Check the fee schedule. Will you incur fees for normal account activities?
how easy is it to withdraw or transfer money from the account? Are there any nearby free ATMs? When will the funds be redirected to your checking account?
Are there other features that make saving money easy? Some accounts have broader savings management capabilities. You might set up multiple savings goals
When you should invest
Cash emergency fund:
You can lower your investment risks with the use of this cash. Any asset you purchase has the potential to depreciate or fail to generate the revenue you anticipated. For instance, the value of stocks changes everyday.
If you have another source of money on hand to deal with monetary emergencies, it will be simpler to accept the typical ups and downs.
If anything catastrophic happens, you might need to sell your investments right away if you don’t have enough cash on hand. Your potential for profit and/or income is lowered when you sell too soon.
Even worse, you can lose money if you sell an asset when its value is momentarily declining.
No high-interest debt; Because you avoid future interest costs, paying off debt guarantees a return. The prospective return and timeline of investing are less certain. Before you begin investing, do the safe thing and pay off your high-interest credit accounts.
How to pick a brokerage account
Your ideal brokerage account should be practical and affordable, similar to savings accounts. The selection procedure is comparable to selecting a savings account, but there is a further complexity. You must first decide what kind of investing account you require.
When you are unsure of your investing timeframe, a taxable brokerage account is the best option.
There are no withdrawal limitations or tax advantages with taxable accounts. Any dividends, interest, or realised profits that you receive will be subject to a yearly tax obligation.
Consider opening an individual retirement account (IRA) if you are explicitly investing money for your retirement. Your earnings are not subject to taxation from year to year with either a standard IRA or a Roth IRA. But there are costs and benefits. If you take money out of your IRA before retirement, you can be hit with taxes and penalties.
Once you decide on the type of brokerage account you need, start shopping for options. Compare prospective accounts on these factors:
Available investments; More is better. At a minimum, you want access to the full range of exchange-traded stocks and funds, plus mutual funds.
Fee schedules; Maintenance and per-trade fees should be minimal.
Look for automation features; Ideally, you’d set up your brokerage account to pull in money and automatically invest it each month.
Pros and cons of saving
Pro:Cash’s worth doesn’t fluctuate. Your savings account balance is not affected by outside variables.
Your savings balance would not change if the stock market lost 50% of its value in a single day.
Pro: Your funds are available for use right away. Cash is movable. This implies that you can use it to make immediate purchases, pay payments, and settle debts. Bonds and stocks cannot be “spent.” You must first turn them into cash.
To invest in the stock market, you must deposit cash into a brokerage account. You then use that cash to buy securities. The first step of depositing the funds is an act of saving.
The best practice is not to invest unless you have a cash savings balance. If an emergency pops up, you’d use your cash to cover the expense. This protects you from having to sell your investment assets before they’ve appreciated.
Saving has two disadvantages relative to investing.
Con: Even after inflation, savings offer negative returns. Cash does lose some of its purchasing power over time. Inflation, often known as rising prices, is to blame for this.The average inflation rate is 2% per year. By the end of the year, $100 in cash will only be sufficient to purchase $98 worth of goods.
You would keep cash in a high-yield account rather than a checking account or beneath your mattress because of inflation. Inflation is somewhat compensated by interest.
For instance, if you earn 0.5% interest on your savings balance, 2% inflation is 1.5%.
Con: Returns on savings are less than returns on investments. Having cash on hand for emergencies is necessary, but doing so comes at a price in addition to the negative real returns.Holding cash eliminates the opportunity to invest and generate profits that outpace inflation.
Pros and cons of investing
Pro: The potential return on investment is high. After accounting for inflation, the stock market has historically grown at an average yearly rate of roughly 7%.
The value of investment assets doubles approximately every 10.5 years at that growth rate.
You would put money into low-fee broad market index funds to have access to market-level growth.
When compared to saving, investment has two drawbacks.
Con: Your assets may depreciate in value. Only what someone is willing to pay for your investments will determine their value. Depending on circumstances beyond your control, that can go up or down.
Con: Before you can spend the money, you must sell your possessions. You must find a buyer, agree on a price, and collect your cash in order to use the value that has been locked up in your investments. This procedure takes a few days for equities and bonds that are traded openly. Real estate and other assets might take months to sell.
Should you invest or save?
Saving is the higher priority when:
- Three months of living expenses are not covered by your cash savings. As was already mentioned, having cash on hand keeps you afloat in the event of unforeseen financial difficulties like job loss, injuries, and other emergencies.
- You have a short-term monetary objective in mind. It’s preferable to save if you intend to purchase a home within five years or pay for your daughter’s wedding the following year. When there is little time left, investing is too dangerous.
You’re ready to invest when:
- You have the means to maintain the investment. Five years is the bare minimum time frame for investing. The stock market can be erratic over shorter periods of time. The likelihood that you will achieve your goals decreases as your deadline gets shorter.
- You are getting ready for retirement or some other distant objective. Long-term objectives are best served by investing. A longer time frame enables you to practise buy-and-hold investing, especially with stocks.
This entails investing in high-quality company shares and seeing them appreciate over many years. It is the easiest method of using stocks to increase wealth.