Saving and investing both play an important part in building a brighter financial future. Both are good habits to create as you work to build wealth. But it is critical to understand what is the difference between saving and investing as you build a financial plan. Ultimately, you’ll need to know the difference between savings and investment to create financial plans that work for your goals.
So, what is the difference between saving and investing? Let’s explore these differences. Plus, dive into the question of whether or not this distinction matters.
What is the difference between saving and investing?
It can be tempting to sweep saving and investing under the single blanket of ‘good financial habits.’ After all, saving and investing both allow you to build your net worth and work towards big financial goals. But the reality is that saving and investing are two distinct actions that have dramatically different impacts on your finances.
First, saving is the choice to tuck funds away for a future expense or goal. As you build your savings, these funds will be available to access quickly. With that, savings are the right choice for funds you want to be able to access on short notice.
For example, you might place your emergency fund in a high yield savings account or build up your funds for a new laptop purchase in a savings account. On the other hand, investing comes with more risk. Although you are also putting these funds away for the future, there is more risk involved.
In exchange for this higher risk, you hope to achieve a higher rate of return. A few examples of investments include tucking funds away in your Roth IRA for retirement or buying mutual funds to pay for a large expense in the future.
Each action plays a critically important role in your financial future. Ultimately, you should build both your savings and investments. But you’ll need to prioritize saving and investing at different points of your financial journey.
The timing of your focus will vary based on your unique financial goals. But both saving and investing matter for your financial future in their own way.
Let’s take a closer look at the advantages and disadvantages of saving and investing.
Pros and cons of savings
Like all financial decisions, building your savings comes with pros and cons. However, building up your savings is still an essential part of your financial plan.
Advantages of savings
Let's start out with the benefits of bulking up your savings accounts. Here are some advantages of savings you should be aware of:
So, you know that your funds are safely held in any FDIC-insured account. Before opening a savings account, take time to confirm that it is FDIC insured.
If you are working with a credit union, then check the account is insured by the National Credit Union Administration. Like FDIC insurance, this will protect up to $250,000 of your savings.
Pre-determined interest rates
When you open a savings account, you’ll know what amount of interest, if any, you will earn on the funds. If the APY changes, you will be notified. A high yield savings account could help you tap into the best APYs available. Take some time to explore the options available to enjoy the best APYs available.
You can tap into your funds anytime you need them. Based on Regulation D, you can make up to 6 withdrawals from your savings account each investment cycle.
With that, you should have no problem accessing the funds you need. But this quick access may serve as a double-edged sword. You might dip into savings when you shouldn't.
Quick to start
You won’t have to learn too much about the world of finances to open a savings account. In most cases, it should take just a few minutes to get the ball rolling. Savings are a way to fund expenses quickly with an extremely low amount of risk involved.
Disadvantages of savings
Of course, there are some disadvantages to saving. Here’s what you need to know:
Another big difference between savings and investment is the amount of return. Savings are low risk, which means they come with low returns. Although these rates are pre-determined, they will often be lower than your potential earnings with an investment.
If the returns are too low, then you might lose purchasing power over time due to inflation. Inflation creates rising prices that slowly erode the value of your dollar. In some cases, savings rates may not keep pace with inflation.
Low returns and the risk of inflation discourage many from keeping too much of their net worth tied up in savings.
Pros and cons of investment
Investments help to build wealth faster, but they do come with their own set of pros and cons. Let’s dive in.
Advantages of investment
Here are the advantages of investment that you should consider:
Potential for higher returns
Again, the difference in savings and investment is the amount of return you will earn. The historic returns of some investments point to higher returns. For example, large stocks have returned an average of 10% per year since 1926.
Of course, past performance is not a guarantee of future success. But these historic returns provide the promise that you can grow your funds with the help of investments.
Potential for liquidity
Depending on the investment you choose, you can find a relatively liquid option. If you invest in stocks, then they can be sold for cash relatively easily. However, you might have to sell at an inopportune moment. That may mean losing money on your investment.
Potential to beat inflation
Inflation eats away at purchasing power. But investing could help you stay ahead of the curve. With the potential for higher returns, you may be able to prevent inflation from destroying your purchasing power. Investing has many potential upsides to help you grow your funds.
Disadvantages of investment
Although there are significant advantages to investing, there are some drawbacks to consider. Here are a few cons to investing:
No guarantee of returns
Investments can fluctuate in value. If you've looked at the stock market lately, you'll quickly realize that there is inherent volatility tied up in this investment choice. Although there are investments with less volatility involved, the returns are never guaranteed. So, you could lose money along the way.
You might even lose money
A big difference in savings and investment is the risk of losing your money. Depending on your investment, you might lose money instead of gaining money.
All investments come with some amount of risk that you might lose your funds. Some investment comes with more risks than others. However, you need to be comfortable with the risks you are taking.
You will need to spend some time learning about your potential investment options to choose the right one for your future. Depending on your inclination, this may take some time. Luckily, we can help get you started. You can learn how investing works with our completely free course!
You’ll find more fees associated with your investments. Before choosing any investment, consider the amount of fees involved. If you go a DIY investment route, you can avoid many of the fees charged by financial advisors. But you'll still encounter fees embedded into your investment choices.
Remember, there are no guarantees when it comes to investing. However, don't let that scare you from investing your money, just be aware of the risks and invest based on your risk tolerance so you can still put your money to work.
When should you save?
It is clear that the difference between savings and investment matters. But when should you choose to save or invest?
If you are just beginning your financial journey, then saving will likely be the first priority. The first steps you should take include paying off any high-interest debt and building up an emergency fund.
Beyond that, savings should be used to meet specific financial goals. For example, you might use a sinking fund to save up for a new car. Or decide to save up for that vacation you’ve been waiting for. Saving is the perfect way to accomplish short-term financial goals.
When should you invest?
Investing requires a more long-term outlook. Before you jump in, it is important to consider your financial goals and your risk tolerance. Once you know where you want your investments to take you, it is time to get started.
The first place that many choose to invest is through their retirement plans. For example, you might invest in a 401k, Roth IRA, or Traditional IRA. The goal of these accounts is to build funds to cover your retirement many years from now. With that, investing is a good fit.
Investing is a useful tool to help you accomplish long-term financial goals. But don’t forget to consider the risks involved.
The difference between savings and investment matters
The difference between savings and investment does matter. Throughout your financial journey, you’ll need to make the choice to funnel extra funds into savings or investments.
Take some time to set up a financial plan so that you know when to save versus invest based on your unique goals. Need help setting up a plan? Check out these ten steps to help you create a solid financial plan.
Make saving much more fun with our "Savings challenge bundle!" This bundle includes money-saving challenges for meal planning, mastering your spending, and the $5 challenge! Also, tune in to the Clever Girls Know podcast and YouTube channel for top tips on saving and investing!