A Quick Guide to Saving vs. Investing
Savings provides money for emergencies or short-term goals while investing takes advantage of higher returns and a longer time horizon for higher earnings.
Thanks to lockdowns brought on by the coronavirus pandemic, Americans haven't been able to keep up with typical spending on travel or restaurant dining. Many people find themselves with more discretionary income than usual. If you're in a situation where you have a few extra hundred or thousand dollars, and you're wondering what to do with it, saving and investing are two excellent options.
When Should You Save
Everyone can benefit from saving money, regardless of other financial goals. Whether it's for an emergency fund, a down payment on a home, or a major upcoming expense, you can't go wrong with stashing money in a savings account. Saving is better for short-term goals, where you're pretty sure you'll need to access the money in the near future.
While saving is typically safer compared to investing, interest rates on savings accounts tend to be fairly low, which means your money won't grow very quickly. And since inflation typically outpaces savings account interest rates, the purchasing power of your savings goes down over time. But, the dollar amount of your savings remains the same, provided you're not making withdrawals.
A high-yield savings account or money market account is a good place to stash your savings because both types of accounts carry less risk than investing. Look for an account with low or no monthly fees, a minimum required amount that you can comfortably meet, and a higher interest rate or APY. If you don't mind having your money locked away for a period of time, you can also purchase a certificate of deposit (CD) for slightly better returns.
The Best Time to Start Investing
Once you've reached your short-term savings goals, for example, you have a fully-funded emergency fund, you can look at maximizing your earnings through investing. Investing involves putting money into assets like stocks, bonds, mutual funds, ETFs, and real estate. These assets have a potential for higher returns than savings but also carry the risk of decreasing in value, depending on the market and other factors. Because of the potentially higher returns, you can reach your financial goals faster and by contributing less money than you would with savings.
Investing is ideal for reaching your long-term financial goals, like retirement and wealth building. A longer time horizon means you can withstand a little more risk than if you needed to access your funds within the next few years because you have more time to wait for the market to recover from any downturns.
If you participate in your employer's 401(k), you're already investing. Contributing the amount needed to get your full employer match allows you to maximize your company benefits, essentially getting free money.
Other investment options include working with a financial advisor or guiding your own investments through an online brokerage like TDAmeritrade, Vanguard, Fidelity, or Charles Schwab. Microinvesting apps like Stash, Acorns, Betterment, and Robinhood are another option for investing on your own.
What About Debt?
You can invest while paying off debt, but keep in mind that your short-term returns may be offset by the high interest rates you're paying on your debt. When it comes to debt, compound interest works against you because you continue to pay interest on your balance month after month until the balance is paid off. Next month, we'll take a deeper dive into investing while paying off debt.
Which is Better for You?
When it comes to savings and investing, you don't have to choose one or the other. Depending on your short- and long-term financial goals, you can split your discretionary income between the two, putting some towards savings and the rest toward investing. It's ok if you're not quite ready to save more money or dip into investing. Tuck this information away until you've taken care of some of your more immediate financial concerns and revisit the topic when you're able.
LaToya Irby is a financial writer with over 14 years of experience. She's been quoted and published as a credit expert in several major publications including USA Today, U.S. News and World Report, TheBalance.com, and The Chicago Tribune.