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Remitly Money Transfer ReviewSaving vs. Investing: Which Option Is Better for Your Money?
Saving and investing are two essential pillars of personal finance, but they serve different purposes. Deciding which is best for your situation comes down to your goals and risk tolerance. Here’s what you should know about saving versus investing, including their differences, similarities, and the pros and cons of each option.
Saving vs. investing: What’s the difference?
While saving and investing can both help you achieve your financial goals, there are key differences to consider.
Saving involves putting funds into banking products, including savings accounts, money market accounts and certificates of deposit (CDs). These accounts are designed for short-term goals and allow you to easily access your money when needed. In contrast, investing involves purchasing stocks, bonds, mutual funds and other investment products for long-term growth and wealth accumulation.
Another key difference is that the money you save in a bank account is typically insured by the Federal Deposit Insurance Corp. (FDIC), which protects up to $250,000 of your deposits in case of bank failure. If you have an account with a credit union, your money is protected for $250,000 through the National Credit Union Administration (NCUA). Investments, however, are not covered by FDIC insurance or by the NCUA.
Learn more: Understanding the Different Types of Savings Accounts
How are saving and investing similar?
Saving and investing both aim to grow your money to meet future needs and wants. Both options involve setting money aside for your financial goals.
For savers, this often involves opening a savings or money market account at a bank or credit union, allowing you to earn interest while keeping funds accessible for short-term needs.
For investors, it can mean opening an investment account through a brokerage firm, such as Vanguard, Fidelity or Schwab, with the goal of long-term growth. Investing can also involve contributing to an employer-sponsored retirement plan, such as a 401(k), or setting up an individual retirement account (IRA).
Pros and cons of saving
Pros
- Safety: FDIC-insured banks and NCUA-insured credit unions protect up to $250,000 per depositor, providing a secure place to store your money. While savings accounts don’t have the high earning potential of investment accounts, the peace of mind they offer can be priceless.
- Liquidity: Savings accounts are highly liquid, meaning you can easily access the money in your account at any time. One notable exception is CDs, which generally charge an early withdrawal penalty if you need your money before the maturity date. You can opt for penalty-free CDs that allow early withdrawal, but these may have lower annual percentage yields (APYs) than traditional CDs.
- Affordability: Savings accounts tend to have minimal fees compared with other financial products. However, some banks charge fees if you exceed the monthly transaction limit.
Cons
- Variable interest rates: Savings account rates can shift along with the federal funds rate, the benchmark rate set by the Federal Reserve. If the Fed lowers rates, your APY may drop as well.
- Relatively low returns: Compared with other higher-risk investments, savings accounts generally offer lower interest rates – meaning your money grows more slowly. To maximize earnings, consider high-yield savings accounts, which typically have higher rates than traditional savings accounts.
- Effects of inflation: Savings accounts don’t always keep pace with inflation, especially if rates are low. This can result in your money's purchasing power diminishing over time.
Pros and cons of investing
Pros
- Potential for long-term returns: Investing offers the opportunity for higher returns compared with savings accounts, but it can come with much higher risk. The stock market fluctuates daily, and while the average historical return of the S&P 500 since 1957 comes to about 10%, these returns aren't guaranteed.
- Tax advantages: You can typically invest in a tax-friendly way, with benefits that include tax-deductible contributions or tax-deductible growth.
- Investments beat inflation, or better: Depending on the product you select, your nest egg can maintain its purchasing power over time.
Cons
- Higher returns – but greater risks: Let’s get one thing clear about investing: You can lose money, especially in the short term. It’s important to invest only money you can afford to lose and consider diversifying your investments to manage risk.
- Fees that reduce the value of your investment portfolio: Investing often involves higher fees than savings accounts. Common charges include advisory fees, trading fees and expense ratios, which can reduce your returns.
- Requires knowledge of financial markets: Investing isn’t as simple as saving money — it requires a deeper understanding of markets and risk management. Many people who are new to the investing world seek guidance from a financial advisor.
Should you save or invest?
When to save money
Saving money may make sense if you’ll need to access the funds within the next few years. In this case, a high-yield savings account, money market account or CD could be the right option for you.
For example, let’s say you want to make a $10,000 down payment on a home in two years. Putting the money in a savings account or a two-year CD can keep your funds safe until you need to make the payment. With a CD, you’ll earn a guaranteed interest rate for the entire two years, making it easier to predict your earnings.
Saving is also a good idea if you don’t have an emergency fund yet. It’s important to save up at least three to six months' worth of expenses to create a buffer against unexpected costs.
When to invest money
Investing can be a wise choice for long-term goals, including retirement, funding a child's college education or other objectives that won’t require funds for several years. While investments offer higher earning potential than savings accounts, they also carry a higher level of risk, especially in the short term. This is why investing is best suited for longer-term goals, as it allows time to recover from market downturns.
Another good reason to invest is if your employer offers a match in your retirement plan, such as a 401(k) or 403(b). The company match is essentially free money and can help boost your retirement savings.
Frequently asked questions
How much money should I put toward savings vs. investing?
How much money to have in savings versus investing depends on your specific goals and risk tolerance. For example, if you have a higher risk tolerance, you may want to consider investing a larger chunk of your money. On the other hand, if you have a more conservative risk tolerance, you might prefer to keep more money in savings or put your cash in lower-risk investments, such as bonds.
Can I save and invest if I have debt?
It’s a good idea to start saving and investing as soon as possible, even if you’re in debt. However, if you have high-interest debt, including credit card debt, it often makes sense to prioritize paying it off first, as the interest rates on debt are usually higher than the returns you can earn from savings and investments.
Should I start saving or investing first?
Generally speaking, it's wise to build up some savings before you start investing. A common rule of thumb is to save three to six months’ worth of expenses in a highly liquid vehicle, such as a savings or money market account. This will help minimize your risk once you start investing, as you’ll be less likely to dip into your portfolio for unexpected expenses.