Ask almost anyone if they know there’s a difference between saving and investing and they’ll say yes. Ask them if they know what that difference is, though, and you’ll get a lot less positive answers.
That’s understandable. After all, saving and investing both stem from the concept of putting aside your money now in order to increase your financial security later. To blur the lines even further, savings and investments both offer interest on the money you put aside.
They’re not the same, though, and knowing the differences between the two could be the key to reaching your financial goals.
What is Saving?
When you save, you’re putting money aside in a secure location in case you need it later. Usually, this secure location is a savings account at a financial institution.
As a result of these goals, savings accounts have three defining attributes. First, the cash has to be readily available. People with money in savings accounts can withdraw some of their assets at any time, although many financial institutions do limit how much their members can withdraw at once (usually $125,000).
The final attribute of a savings account is that their rate of return is a lot lower than the rate of returns on investments. High-yield savings accounts might give you over 2% interest, but most of the time expect anywhere from a 0.01% to 0.15% interest rate.
What is Investing?
When you invest money, on the other hand, you’re trying to reach bigger financial goals that are at least four to five years away. These can include saving for things like retirement or your child’s college education.
Money in investment accounts differs from savings accounts in a few notable ways. The most notable way is that you have a lot more potential for profit than if your money is in a savings account. In an index fund, for instance, you can reasonably expect your money to earn 7% to 9% interest a year, and that’s without taking into account what you’ll earn with compound interest.
However, investing your money also involves risk. The stock market may crash, businesses can go bankrupt and property values can fall. In the case of failed businesses like Enron or Theranos, the Securities and Exchange Commission might investigate for fraud and lawsuits may be filed, but you won’t get much, if any, money back.
Finally, investment accounts do not let you access your money as easily as a savings account. If you want to take your money out of an investment account, you’ll have to make sure the right forms have been filled out and processed first.
How to know whether to save or invest?
Knowing the difference between saving and investing raises another question. When should you save and when should you invest?
If you’re just starting to put money away and you can only select one option, start with putting money in a savings account. Once you have at least $500, you’ll have a good emergency fund set up for an unexpected car repair or a sudden medical emergency.
There’s one exception to this rule, though—if your employer offers a 401(k) match program, put in the maximum amount. If you don’t, you’re losing out on tons of free money.
Once you have at least $500 in a savings account, you can start to split the money you put aside between saving and investing. How much you want to put in either account is a decision that will depend heavily on your personal situation, but remember that investing is for long-term goals, while saving is for short-term goals. Save and invest your money accordingly, and periodically check to see if you need to focus on one type of goal more than the other.
Meet Your Financial Goals with First Alliance Credit Union
When you know the difference between saving and investing, you can use both methods to help you achieve your financial goals. If you want some help deciding which option is best for you, contact Member Services at First Alliance Credit Union. Our expert team of advisors will help you get started making your money work for you.