People frequently use “saving” and “investing” interchangeably, but it’s important to understand the distinct roles each plays in our financial lives.
I’ve frequently heard people use the words “saving” and “investing” interchangeably. But while these concepts are related, it’s important to understand their distinct roles in our financial lives. If you don’t, you risk jeopardizing your short- and long-term goals, and even your financial security.
Saving means storing your money in cash, like parking your funds at a bank that pays some small amount of interest, like in a savings account or certificate of deposit (CD). Meanwhile, investing refers to exchanging your cash for some kind of ownership that could bring you a future monetary benefit, like buying stocks, bonds, mutual funds, ETFs or other kinds of investments.
Generally, investing has the potential to earn higher returns, but it also bears the risk of market loss.
Saving tends to be best for short-term goals because if you need your money back really soon, you might not have much opportunity to recoup any losses. Investing tends to be best for longer-term goals because you’ll generally have more time to compensate for fluctuations in your portfolio.
There are some cases where saving may make more sense than investing:
- You don’t have much time: Maybe you’re saving for a purchase only a few months or a year in the future and you can’t risk not hitting your goal.
- You need liquidity: Savings tend to be more liquid than investments. Many bank accounts allow for quick withdrawals (although there may be rules for some savings accounts), whereas you might need to liquidate your investments before you can withdraw money from a brokerage account. Note that CDs may not allow you to withdraw money without incurring fees or penalties.
- You can’t tolerate losses: Would you risk your wellbeing if you lost these funds? Bank accounts at accredited institutions are insured by the Federal Deposit Insurance Corporation (FDIC) to at least $250,000.
- You’re prepared to fund your goal primarily with your own money: Imagine that you’re funding your short-term goals chiefly with your own hard-earned dollars, rather than depending on interest or earnings. Interest is icing on the cake, but the majority of the funds will come from your own pocket.
- Your savings aren’t enough alone: In some cases, the dollars and cents you save up may not, alone, be enough to achieve your goal. When it comes to retirement, for example, the lower rate you can earn from savings account interest simply may not get you there.
- You have a longer timeline for this goal: Maybe you have 15 years before your child will enter college, or a few decades before you retire. When you have more time to recoup potential market losses, you may have a higher risk tolerance, enabling you to pursue higher earnings potential.
If you invest when you should be saving, you run the risk of losing too much money and being unable to meet your goal. On the other hand, if you save when you should be investing, you could lose out on earnings potential. That, too, could stand in the way of achieving your goal.
Another problem is that if you stash your cash somewhere that doesn’t earn high interest rates and fails to keep up with inflation, your money’s buying power could erode over time—essentially losing you money
Even if you’re investing toward long-term goals, the market may not be able to do all the hard work for you. In my experience, the most successful investors are those who keep contributing money to their investing accounts over time. The more they contribute toward their goals, the more that new money has an opportunity to grow, too.
Inevitably, the market will sometimes post losses. But you may be able to harness that volatility by adding to your investments on a regular basis, enabling you to buy at low prices while the market’s down. In fact, contributing regularly to your investments might allow you to dollar-cost average, a technique that might be able to help mediate risk over time.