What's the difference between saving and investing?
Both saving and investing are ways to use your money for a purchase or goal down the road. Saving is typically done for shorter-term needs where protecting your money and being able to access it easily are top priorities. Investing is usually for longer-term goals where growing your money is the most important goal.
Because saving and investing are in some ways similar, many of the same ideas apply to both, including the risk of losing money, how easy it is to access your funds, and potential gains (i.e., how much money you might make, also called your rate of return). But there are significant differences in exactly how those ideas apply and also in how you actually go about saving versus investing. Let's break down the details.
What is saving and what is investing?
Saving usually means regularly setting aside money for a relatively short-term goal or need such as emergency expenses, buying a car, or taking a vacation. Savings accounts are typically low risk, but also offer low returns, meaning your savings won’t earn very much additional money (which is paid to you as interest).
Savings are often deposited into a savings account at a bank, a bank certificate of deposit (CD), or a bank money market account.
In contrast, investing typically involves buying assets such as stocks, bonds, or shares in mutual funds or exchange-traded funds (ETFs) that have the potential to increase in value over time. Investing is often done with long-term goals such as retirement in mind. With investing, the risk of losing money is almost always higher than saving, but the potential to grow your money and build wealth is typically also much higher.
Investing is usually done through a retirement account such as a 401(k) or IRA, or through a more general-purpose brokerage account. These types of accounts hold the investments you purchase such as stocks, bonds, mutual funds, and ETFs. Of course, it's also possible to invest some of your money in physical assets such as real estate.
What are the main differences between saving and investing?
For saving, the key factors are:
- It involves minimal risk—much less than investing. Funds deposited in almost any U.S. bank or credit union are insured up to at least $250,000 per depositor by the Federal Deposit Insurance Corporation (FDIC). Bank CDs and money market deposit accounts are also FDIC-insured. This is a big reason why saving may be the best choice for short-term goals: There’s almost no chance that you’ll lose money and be forced to abandon or postpone your goal.
- You can access your money quickly. This is what financial professionals call "high liquidity", which just means that an account or an asset you own can be turned into usable cash with very little delay.
- The potential to grow your money is comparatively low. The rate of return—the interest rate that you earn—on a savings account or CD is very likely to be much lower than your potential rate of return on an investment such as stocks or ETFs.
In fact, it's often true that the interest rate paid on a savings account is lower than the rate of inflation. When that happens, money in a savings account is actually losing buying power over time, even though it's earning interest. A premium (i.e., higher interest) savings account may reduce this risk.
For investing, the main factors are:
- You enjoy potentially higher rates of return compared to saving. Simply put, your money may grow more. Historical rates of return in the stock market, for example, are several times greater than returns from savings accounts or CDs over the same time frames.
- There's more risk than saving. You're not insured against losses caused by market drops. In other words, you could lose money if the market goes against you. This risk may be especially pronounced over short time periods.
- Might take a bit longer to access your cash. Typically, there are restrictions on withdrawing money from retirement accounts like 401(k)s. Even when there are no restrictions, as with a regular brokerage account, it may take time - up to two days to settle is the industry standard - and fees may apply to sell investments like stocks and bonds and convert them to cash that you can withdraw.
How is it used?
Most often used as a place to securely store money for shorter-term goals or in case of an emergency.
Access to cash
Typically, accessing cash is easy and does not incur penalties, although sometimes there are monthly limits on frequency of withdrawals.
Funds deposited in the account earn interest, but returns will likely be relatively low.
Risk is minimal; funds are FDIC-insured up to at least $250,000.
How is it used?
Typically used for longer-term investments such as retirement.
Access to cash
Depending on the investments or account type, you may not be able to withdraw funds quickly (up to two days to settle) and you may incur penalties.
Potential for higher returns than a savings account.
It's possible to lose some or all of the money you invest.
Should I be saving or investing? Which comes first?
With one exception, certain saving priorities should likely come before you start investing. When deciding whether it's time to save or invest, here are some principles to keep in mind:
- Set up an emergency fund first. It's a good idea to have three to six months' worth of living expenses saved in case of unforeseen events.
- Pay off high-interest debt. If you have debt and the interest you're paying is higher than what you can earn in a savings account or may potentially earn from investments, pay off that debt first.
- Don't miss matching 401(k) contributions. This is the exception we mentioned. If your employer will match some of your 401(k) contributions, you’ll very likely want to contribute at least enough to get the full match, if you can. You may want to do this even if you’re still working on the first two saving priorities—it's like getting free money.
- Be clear about your priorities. Are your most important financial goals short-term, such as buying a car, or long-term, like retirement?
- In the same vein, consider when you will use the money. Again, saving often makes the most sense for short-term needs.
- Know your risk tolerance. Understanding how much risk you're comfortable with can help guide your decisions about saving and choosing lower-risk or higher-risk investments.
What to look for in a savings account
- FDIC insurance. Almost all banks are covered by the FDIC, but it's worth double-checking to be sure.
- A high annual percentage yield (APY) is a good figure to compare interest rates. Most banks pay low interest rates on deposits, but there are differences, so shop around.
- Monthly fees. Some banks waive fees if you have a large enough balance or meet certain criteria. Others won’t charge a monthly fee no matter what. Try to find a savings account that’s free for you.
- Local or online. Location might be important, but keep in mind that most digital banks emphasize online tools to make it easier to save and to manage your account from anywhere.
- Easy access to your cash when you need it.
What to look for in a brokerage firm or other investment provider
- Fees and other investing costs. Generally, there are fees and possibly commissions associated with investing. But fees can vary widely, depending on the broker and what investments you make. You'll want to look at this carefully.
- Range of investment choices and accounts available. Make sure your broker offers the types of accounts you need and access to the markets and products, such as mutual funds and ETFs, that you might want.
- Research and other tools. There are literally tens of thousands of stocks, bonds, funds, and other investments available on the various markets. Easy-to-use research tools, investment screeners, and other educational resources can make a big difference when you're trying to find the right investments for you.
- Support. Your investments are important—it's your money, after all. Can you get your questions answered and problems solved quickly and efficiently?
- Easy access to your cash when you need it.
In the end, both saving and investing have their place, and many people will do them simultaneously. That's because most of us have specific short-term goals for which saving is appropriate as well as long-term objectives where investing may make more sense.
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