We often use the terms “saving” and “investing” interchangeably. After all, both refer to key habits you must practice in order to achieve financial success. But they’re not really the same.
Saving is setting money aside for (usually short-term) future use, separate from what you plan to spend right now. Investing is taking the money you’re saving and using it to purchase assets that you expect to pay returns over time—in other words, helping you grow your wealth.
How do you decide what money to save and what to invest?
First, you have to sort out your financial goals and determine your timelines for achieving them. Typically, you’d want to save money for goals you’d like to accomplish within a year or so. For anything that will take longer, you may be able to afford to invest the money.
Why does timeframe matter?
When you’re shooting to reach a goal soon, you want to be sure the money will be there when you need it—and saving offers the best change of that. The tradeoff for safety, though, is that money saved doesn’t tend to earn much while it sits. For example, even the highest yielding savings account right now offers a rate of just 2.39 percent, according to Bankrate. The average savings account comes with a rate of merely 0.10 percent, as of mid-January 2019. The upside: You can rest assured that the money you’ve put into the account will be there, whenever you need it.
Investing can generate greater returns—but with greater risk and ups and downs. For example, aside from some rocky months in 2018, stocks have been on a tear in recent history—gaining 267 percent from March 2009 through December 2018. But in the last bear market (generally defined by a drop of 20 percent or more from the recent peak), the S&P 500 plummeted 56.8 percent between October 2007 and March 2009 before it began to recover.
Over the long term, though, the stock market has historically always gone up. Since its inception in 1928, the S&P has returned about 10 percent a year, on average. So if you have a long timeline for a particular financial goal, such as retirement, the idea is that there’s time to recover from the bumps along the way.
Plus, you can—and should—invest in more than just stocks, like bonds, real estate and, of course, cash. That way some of your holdings have a chance to increase even as others might drop, and investing can continue to help you meet your goals no matter what any one investment does.
And I have to save and invest?
If you want to be financially healthy. You need some savings on hand to at least cover yourself in an emergency. Most experts advise people to have three to six months’ worth of expenses squirreled away in an emergency fund. And even as you work to save for the short term, you also want to invest for the long term to maximize the time that money has to grow. The best chance to set yourself up financially is to get in the habit of consistently saving and investing.