One of the first pieces of financial advice many people hear growing up is Ben Franklin's adage "A penny saved is a penny earned."
But if you're focused solely on saving, you're missing out on an opportunity to grow wealth. "Nobody ever got rich just by saving money," self-made millionaire and early retiree Steve Adcock recently told Grow.
The proven strategy: investing.
Make no mistake, it's important to both save and invest. Each has an important role to play.
Saving is key for short-term goals: You won't earn much, but you aren't at risk to lose that cash, either. And it's easy to access in an emergency.
"This year, with all the turbulence surrounding the coronavirus, unfortunately too many people are seeing how important it is to have an emergency reserve," says Neal Solomon, managing director of WealthPro LLC in Gloversville, New York.
However, he says, "what savings accounts are not good for is building long-term wealth." The reason for that is inflation, or the broad increase in prices that reduce the purchasing power of your money.
Video by Courtney Stith
"If your parents sent a birth announcement in the mail when you were born, someone might mail back a dollar bill as a congratulations," Solomon says. "That dollar could have bought, say, five stamps. If you still had that dollar bill today, it would be less than two stamps."
Inflation has been averaging 1.9% per year from 2010 to 2019. To compare, current rates for a savings account in 2020 are 0.12% per year, according to DepositAccounts.com — with the very highest ones averaging 0.92% — meaning you're not earning enough to outpace inflation.
Investing, by contrast, "allows you to increase the buying power of your money to account for inflation."
It's normal for stock prices to fluctuate, and investing does entail risk. But the S&P 500, the benchmark index for U.S. stocks, has delivered average annual gains of about 14.2% from 2010 to 2019, and its long term annualized average is about 10%.
Factor in the power of compounding — meaning you earn a return not just on your money but also on the interest it has already accrued — and you're well on your way to building wealth for long-term goals like retirement.
Start by prioritizing your financial goals. Most financial experts would agree that you should first save to build up an emergency fund, while paying down high-interest debt and investing at least enough to get the full match on your 401(k). Once you have a good emergency reserve, you can accelerate your investing.
Once you have emergency fund built up, aim for a mix of saving and investing, says Marguerita Cheng, a certified financial planner and CEO of Blue Ocean Wealth in Gaithersburg, Maryland. She is also a member of the CNBC Advisor Council.
Video by Jason Armesto
Cheng gives her clients a formula to work with, especially if money is tight. If a client tells her that they have, for example, $200 total to commit to financial goals: "Of that, $100 might go to cash reserves and $100 should be long-term investments," she says. If someone is in debt, then $100 goes to debt repayment instead of investing.
Adapt to what's right for you. Cheng emphasizes the importance of adapting to your individual situation, as well as what path helps make you feel financially resilient.
As Cheng puts it, "Personal finance is very personal. The textbooks say you should pay every dollar of credit card debt before investing. The textbook is missing the human element. If [investing or saving] give you peace of mind instead of paying the debt, then do it."
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