Saving or Investing: Is There a Difference?
Financially speaking, the terms “saving” and “investing” are often used interchangeably. But the concepts behind these terms actually have some important differences. Understanding these differences and taking advantage of them may help you in working toward financial goals for you and your family.
You may want to set aside money for a specific, identifiable expense. You park this money someplace relatively safe and liquid so you can get the amount you want when you need it. According to the Securities and Exchange Commission brochure Saving and Investing, “savings are usually put into the safest places, or products, that allow you access to your money at any time. Savings products include savings accounts, checking accounts, and certificates of deposit.” Some deposits may be insured (up to $250,000 per depositor, per insured institution) by the Federal Deposit Insurance Corporation or the National Credit Union Administration. Savings instruments generally earn interest. However, the likely tradeoff for liquidity and security is typically lower returns.
While a return of your money may be an important objective, your goal might be to realize a return on your money. Using your money to buy assets with the hope of receiving a profit or gain is generally referred to as investing. Think of investing as putting your money to work for you–in return for a potentially higher return, you accept a greater degree of risk. With investing, you don’t know whether or when you’ll realize a gain. The money you invest usually is not federally insured. You could lose the amount you’ve invested (e.g., your principal), but you also have the opportunity to earn more money, especially compared to typical savings vehicles. The investment is often held for a longer period of time to allow for growth. It is important to note, though, that all investing involves risk, including the loss of principal, and there is no assurance that any investing strategy will be successful.
What’s the difference?
Whether you prefer to use the word “saving” or “investing” isn’t as important as understanding how the underlying concepts fit into your financial strategy. When it comes to targeting short-term financial goals (e.g., making a major purchase in the next three years), you may opt to save. For example, you might set money aside (i.e., save) to create and maintain an emergency fund to pay regular monthly expenses in the event that you lose your job or become disabled, or for short-term objectives like buying a car or paying for a family vacation. You might consider putting this money in a vehicle that’s stable and liquid. Think of what would happen if you were to rely on investments that suddenly lost value shortly before you needed the funds for your purchase or expense.
Saving generally may not be the answer for longer-term goals. One of the primary reasons is inflation–while your principal may be stable, it might be losing purchasing power. Instead, you may opt to purchase investments to try to accumulate enough to pay for large future expenses such as your child’s college or your retirement. Generally, saving and investing work hand in hand. For instance, you may save for retirement by investing within an employer retirement account.
Why is it important?
Both saving and investing have a role in your overall financial strategy. The key is to balance your saving and investing with your short- and long-term goals and objectives. Overemphasize saving and you might not achieve the return you need to pursue your long-term goals. Ignore saving and you increase the risk of not being able to meet your short-term objectives and expenses. Get it right and you increase your chances of staying on plan.
Over the past few decades, a field has emerged that examines how human psychological factors influence economic and financial decisions. Understanding these biases may help you avoid questionable calls in the heat of the financial moment.