It’s common for people to use the terms spending and investing interchangeably. But in reality, they represent entirely different concepts. They are both vital components in your financial plan, but if used incorrectly, they can result in disaster. So it’s important to understand the difference between the two and how they can work together to help you reach your goals.
So what’s the difference between saving and investing? Should you prioritize one over the other? Let’s take a closer look.
What is Saving and Why is it So Important?
Think about saving as a type of financial protection. It’s there to make sure you can pay all your bills on time, bail you out of a tough situation, or spot you some cash when something big breaks. Essentially, it's money you know you can’t lose.
Since saving is a type of protection, you won’t see a significant return. As the saying generally goes, low-risk profits yield low returns. The average return for a savings account is very minimal, yielding 0.06%.
Opening a high-yield savings account is an easy way to earn more returns. This type of savings vehicle pays a higher yield on your money. For example, Ally Bank’s savings account offers a rate of .50%—that’s quite a jump from .06%! These banks are typically online-only, which is why they can offer a higher average return because they don’t have the physical building to pay for.
Even with a high yield savings account, sticking all of your cash in savings won’t earn you your first million. If it were that easy, we’d all do it.
Why is saving so important then? It can keep you out of trouble because that money is always available for you to use no matter what and without penalties. Savings is excellent for an emergency fund and other safe investments like a certificate of deposit.
What's Investing, and Can it Help You Achieve Your Financial Goals?
Investing involves putting your money in specific funds or buying assets like stock or property to make your funds grow. While far riskier than saving, investing exposes your portfolio to more growth.
How much growth is possible with investing? The S&P 500 averages a 10% return year over year. Even when utilizing a high yield savings account, investing could help you earn nearly 10% more on returns.
Investing is a great way for you to build wealth, and when compound interest is involved, it can be a game-changer. Compound interest grows your wealth at an accelerated rate because you earn returns on the money you invest and on returns at the end of every compounding period. This means that you don’t have to invest as much money to reach your financial goals!
For example, let’s say that your initial deposit is $6,000 with monthly contributions of $100. Over 5 years at an 8% rate of return compounding month, your future balance would be over $16,000. It’s not magic; it’s compounding interest. Try it out for yourself on this compounding interest calculator to see what we mean!
Some of the most common investment vehicles include:
- 401k or IRA retirement plan
- Brokerage account to buy and sell stocks, bonds, and mutual funds
- Education accounts like a 529 plan to save for higher education
- Health Savings Account to pay for deductibles with tax-free gains and pre-tax contributions
Saving or Investing: Which Should You Prioritize To Reach Your Goals?
Saving and investing are quite different, but they do have one thing in common: they are both vital to reaching your financial goals. As to which you should prioritize, that will likely change throughout your life.
Your financial goals in your 30s will probably be a bit different than your financial goals in your 50s. The good thing is that you don’t have to pick one or the other; rather, you can do both simultaneously.
You’ll get a better idea of which to prioritize once you fully understand your short-term and long-term financial goals. A short-term goal could be to buy a car or go on a tropical vacation to Hawaii, while a longer-term goal may be to eliminate credit card debt or save for retirement.
Once you have your financial goals in place, rank them from highest priority to lowest. This will give you and your advisor a better idea of how to adjust your financial plan. An adjusted financial plan could look like saving $200 a month into an emergency fund until you reach your desired number, then reallocating that money to retirement or a brokerage account.
At the end of the day, it’s important to prioritize three things:
- Building an emergency fund with 3-6 months of living expenses
- Saving for retirement by maxing out your accounts when possible
- Eliminating debt and, more specifically, high-interest debt
We Can Make A Plan Together
So what should you do: save or invest? You don’t want too much cash in your portfolio, but you do want enough to protect you in case of an emergency. It can be overwhelming trying to decide on your own, but we can look at your situation together and create a plan that works for you.You need both saving and investing in your financial plan, so let’s figure out the best balance for you. Get in touch with our team here to get started on a journey to financial wellbeing.