Saving Vs. Investing: What’s The Difference?
Both saving and investing are part of building wealth, but there’s a difference that’s important to understand.
Clarity on the distinction can help you make good decisions on how to handle your finances. It can also guide you as you consider which types of accounts best meet your needs, helping to prevent costly mistakes.
This article explores…
- …the difference between between saving and investing
- …the role of investing vs. saving
- …examples of where to put savings and investments
- …tips on how to save and how to invest
Compare current savings account rates
The Difference between Saving and Investing
IN THIS ARTICLE
Saving and investing are related, and people sometimes use these terms to mean the same thing – but they’re not.
“Saving” is the process of setting money aside and keeping it safe for future use.
The main tasks involved in saving are…
- …setting up a budget so you don’t spend all the money you earn
- …putting the money you don’t spend in a safe place.
“Investing,” on the other hand, is the process of trying to grow the money you have so it will be worth more in the future.
The main task involved in investing is making decisions about buying things you hope will increase in value over time. Successful investing involves understanding what affects the value of investments and coming to terms with how much risk you are willing to take.
So essentially, the difference between saving and investing comes down to risk and reward.
With savings, the primary goal is to keep your money safe. Minimizing risk means accepting the fact the return that money earns will be very limited.
With investing, the goal is to put the money to work so it will be worth more in the future. Trying to earn more of a reward on your money involves taking some risk, which could also include the possibility of permanent losses.
Is it Better to Save or Invest?
So which is better – keeping risk to a minimum or aiming for more reward?
The answer depends partly on what you need the money for and partly on your general financial situation.
There are times when the smart thing to do is keep your money safe. In other cases, you would be wise to go for a higher return.
Most people have need for both. They determine that some money should be set aside safely and some should be invested to grow for the future.
Knowing how to divide your money between saving and investing means understanding the different roles each can play.
The Role of Savings vs. Investments
The purpose of savings is to make sure the money is there when you need it. That’s why safety is the number one consideration.
Savings can be kept safe for purposes such as:
- Significant payments you expect to make in the months ahead
- Major purchases you are saving up to make in the next five years or so
- An emergency fund to cover unexpected expenses
Safety is great for these purposes, but it has its drawbacks when it comes to meeting long-term needs.
When you keep your money safe, you can expect it to earn very little. You may need more growth than that to accumulate enough money for retirement. In fact, some savings earn less than the rate of inflation, so your money would actually be losing purchasing power over time unless you invest it.
Taking risk in an attempt to earn a higher return by investing can serve purposes such as:
- Accumulating money for long-term, major expenses like a child’s college education
- Growing a nest egg to support your retirement
- Building wealth once you know your immediate financial needs can be safely met
If you’re like most people, you have both types of needs. There are some near-term things you count on your money being available for, and also reasons you need to grow your money for the future.
That’s why there’s probably a place for both savings and investments in your financial mix.
In fact, over time money can transition from savings to investment accounts, and vice versa.
You may initially set aside money into safe savings vehicles, but once you’ve accumulated enough savings to meet your needs and have had a chance to figure out how to invest some of the extra, you can transition some of that money into investments.
On the other hand, you may invest money for long-term goals like retirement; then, as those goals get closer, you may start to transition some of those investments into savings so the money isn’t at risk of losing value and will be available when you need it.
Examples of Where to Save Money
Since safety is the number one goal for savings, the best choices are federally insured deposit accounts. These are bank deposits insured by the Federal Deposit Insurance Corporation (FDIC) or credit union deposits insured by the National Credit Union Administration (NCUA).
Insured deposits include:
- Checking accounts
These are convenient for handling routine payments, but not ideal for saving money. They typically pay less interest than other deposit accounts, and their ease of access may make it too tempting to spend rather than save money in them. - Savings accounts
These typically pay higher interest than checking accounts but put limits on how you can access them. Those characteristics make them well-suited to saving money. - Money market accounts
These work much the same way as savings accounts but may have different account terms and requirements. You should compare savings and money market accounts to get the best fit for your needs. - Certificates of deposit (CDs)
These involve committing your money for a specified amount of time. In return, CDs generally pay higher interest rates than savings or money market accounts. These can be good savings vehicles for planned expenses because you can match the length of the CD with when you will need the money.
Before making a deposit in one of the above types of accounts, check that the financial institution is covered by FDIC or NCUA insurance. Also, make sure your deposits are within the applicable insurance limit, which is typically $250,000 of any customer’s total deposits at any one institution.
Compare current savings account rates
Tips on How to Save Money
Saving money involves both setting aside the money to begin with and then putting it in a safe place. Here are some tips for how to do this:
- Make a budget
Your budget should include a regular amount that you deposit into savings. Don’t count on just saving what’s left over after spending because that makes it too easy to spend whatever you have available.
- Choose an insured deposit account
Make sure that the financial institution you select is a member of the FDIC or the NCUA, and that the type of account you open is covered by deposit insurance. Also check to see that your total deposits at that institution do not exceed $250,000.
- Shop around to get the best interest rates
Even though safety is the first consideration with deposit accounts, that doesn’t mean you should ignore the opportunity to safely make a little extra money. The America’s Best Rates Survey by MoneyRates has consistently found that the top savings account rates are more than a full percentage point higher than the average. There can be similar differences with money market accounts and CDs, so shop before you commit to an account.
Examples of Where to Invest Money
If you want to invest in more growth-oriented things such as stocks, bonds and real estate, the following can facilitate these types of investments:
- Brokerage accounts
Brokerage accounts enable you to invest in a wide variety of publicly traded securities. This includes investments in individual securities or funds which hold diversified portfolios of securities.
Brokerage accounts typically give the customer the responsibility for choosing which investments to make. Online brokers may be the best fit for newer investors because they generally have lower minimums and cheaper costs.
- Robo-advisors
Robo-advisors are automated platforms that put together portfolios of investments based on your general characteristics. A robo-advisor may be an appropriate choice if you don’t want to make your own investment decisions and you don’t need individualized attention or much account customization.
- Investment advisors
A registered investment advisor can take fiduciary responsibility for making investment decisions on your behalf. They can provide individual attention and a customized approach, but this typically comes at a higher cost.
Best Online Brokers for Stock Trading
Tips on How to Invest Money
Investing is a complex subject that you should research before you start putting your money on the line. Some of the basic steps include the following:
- Decide whether you want to make investment decisions or have it done for you. This will determine whether you need a brokerage account to allow you to buy and sell the securities you choose, or a robo-advisor or investment manager to make those decisions for you.
- Research brokers, robo-advisors and other investment firms to see which offer the products you want. Once you get an idea of what kind of investing you want to do, check out which firms have the right product mix to meet your needs.
- Compare costs so they don’t eat too much into your investment growth. Online brokers generally have lower costs than brokers offering in-person service. There are also significant differences in how robo-advisors and investment mangers charge and the costs of their services.
Savings and investments are both likely to be part of your financial picture sooner or later. The first step toward handling them correctly is to make a clear distinction between money you want to save and money you want to invest. That way you can make the appropriate choices for each.
Frequently Asked Questions
Q: I see the stock market and real estate are improving every day, so why do we still see these ridiculously low rates on CDs and savings accounts? Are those rates going to improve soon, or do we have to put our money into the stock market?
A: You’ve put your finger on the Catch-22 facing investors these days: Low interest rates are driving investors into stocks, but if stock prices go up solely because interest rates are low, those stock prices may be vulnerable when interest rates start rising.
A look at the numbers reveals why this dilemma is so tough. The S&P 500 stock index has risen over the last several years. More recently, home prices are very high.
Meanwhile, rates on savings accounts and other deposits seem stuck in the mud. As of the end of April, the average savings account interest rate was just 0.06%, which is even lower than savings account rates were three years ago. It’s only natural that investors should be looking to stocks and other risky investments as an alternative.
The problem is that while stock prices are up, the overall economy has made only sluggish progress. This suggests that stocks are up primarily because investors lack for better alternatives, and that’s a shaky foundation on which to build a market rally.
So what are you to do in this situation? It’s probably best not to look at it as an all-or-nothing proposition. You might incline a little more toward stocks in this environment, but that doesn’t mean you should cash in your savings accounts and put every penny into the stock market.
Before taking on more stock market risk, ask yourself these fundamental questions:
- When are you likely to need this money? If you’ll need a substantial portion of the money within the next five years or so, stocks may not be an appropriate investment.
- Do you have a sufficient emergency fund? This would help you avoid having to cash out of stocks at an inopportune time.
- Are you emotionally prepared for the ups and downs of the stock market?
As for the money you keep in deposit accounts, while there are no signs that interest rates are going to rise anytime soon, there seems little point in locking yourself into a long-term CD at today’s rates. Keep your money flexible by concentrating on short-term CDs, money market accounts or savings accounts. It’s hard to say when rates will rise, but you want your accounts to be able to react quickly when they finally do.
Q: How do you rate the pros and cons of stocks compared to savings accounts?
A: It’s a bit like comparing apples and oranges. But looking at the contrasts between stocks and savings accounts is a good way to highlight the strengths and weaknesses of each.
Listed below are three key characteristics you might use to evaluate possible investments, along with some comments on how stocks and savings accounts stack up in these categories.
Investment risk
Do you want to be sure you won’t lose money? Then stocks are not for you. The stock market goes up and down every day, and can have sustained declines where it might lose more than 20 percent in one year. Individual stocks are generally even more volatile than the market as a whole.
In contrast, savings accounts are designed never to lose value. In addition, U.S. bank savings accounts are backed by FDIC insurance up to a limit of $250,000 per depositor at any one institution (i.e., you can get more money insured if you spread your deposits out among multiple institutions).
Liquidity
This is a question of how readily available your money will be. As noted above, stocks are subject to ups and downs, so you can’t be sure exactly how much money will be available at any given time. Also, the process of selling stocks may cause slight delays in accessing your money. This may result in a reduced value due to taxes, commissions and market fluctuations.
Here again, savings accounts are quite the opposite, as one of their key attributes is that your money is available at any time. The one restriction is that you are limited to six withdrawals per month. As such, you should not use a savings account for frequent transactions the way you would a checking account.
Growth potential
Stocks represent ongoing business ventures and thus have considerable growth potential, though it is far from a sure thing. Unfortunately though, so far in the 21st century earnings on U.S. stocks have increased at an average rate of just 3.32 percent a year, so you would not exactly be tapping into a high-growth phase of the stock market.
Still, even 3.32 percent looks robust compared to the 0.06 percent average interest rate on savings accounts these days. You can get a much better yield (up in the 1.0 percent territory) if you shop around for the best savings accounts. However, stocks definitely have the advantage when it comes to growth potential. Just remember that potential is not a sure thing.
Clearly, these investments are designed to do very different things, so the starting point for this type of decision is to figure out the purpose of the money you are trying to invest. Is it something you need to be sure of in the near future, or are you looking for long-term results?
Both stocks and savings accounts have very worthwhile purposes. This is why people with well-developed investment programs tend to have a mix of both types of assets, as well as bonds.
