When it comes to preparing for the future financially, most throw around the words: "saving" and "investing", as though they are interchangeable terms and concepts. In reality, saving and investing are two different approaches to building a wealthy financial future. The key to using each successfully to secure your financial health for the future, is to understand the important differences between each approach.
Different Approaches
The most important aspect you should understand about saving and investing is the difference of each approach. As a general rule of thumb, saving is a good short-term activity for accumulating modest financial reserves. Investing is a long-term strategy to accumulate moderate to high levels of financial reserves. You should strive to engage in both approaches to building wealth, but also have an understanding of the limitations with each.
For example, there is a limited advantage to saving money long-term because the amount of interest it can earn is modest at best. Conversely, investing should not be done short-term because the risk is often greater than the reward in the short term. Keep in mind that with both approaches, when the risk goes down, liquidity goes up.
Biggest Difference: Risk
There are several slight differences between saving and investing, but the most important difference to focus on is risk. For example, when you save money you are putting cold, hard cash aside in a relatively safe place: such as, a money market account or Certificate of Deposit (CD)1. These serve as a short-term means of earning small amounts of interest while keeping cash liquid, without exposing the funds to a high degree of risk.
On the other hand, investing offers the chance to earn greater interest and greater reward, but comes with a higher potential for financial loss.
The Benefit of Interest
It takes money to make money. This saying is applicable in the world of investing. The major focus of investing is for you to make money. The goal of saving, on the other hand, is to protect money you have already acquired.
Bankrate hightlights some of the major advantages of saving and investing, starting with the purpose of a CD, for example. A CD is a savings tool that offers a lifespan of just a few months to as many as 7 years. It keeps your money in a safe account and allows it to grow at a rate slightly higher than a standard savings account.
Compound interest, on the other hand, is a major benefit of investing. When you invest earlier and allow your money to grow larger over time, it creates compound interest. This can help you turn a small pile of cash into financial security by the time you retire.
When Should You Save?
There is a time and a place for saving money. If you are planning on making a major purchase, be it a house or a new car, it is a good idea to set aside money in the short term. Generally speaking, it is also a good idea to save money on a regular basis to ensure you have cash on hand to cover any emergencies that arise.
If you are saving toward a specific goal, such as that new car or house, then it is a good idea to track your savings with a deadline or timeline. This way you have a means of tracking your goal and figuring out how long it will take you to achieve that goal.
When Should You Invest?
For those interested in investing, make sure that you do so wisely. Whether you are saving for your retirement or a college fund for your children, it is important to select the appropriate investment vehicle to ensure you have a better chance of achieving the financial goal you have set forth.
For example, ESA or 529 plans are good long-term investments for parents saving for a child's future college tuition. These vehicles are geared toward the long haul, and allow children to withdraw money for school expenses as needed.
Start Sooner, Rather than Later
The best time to start investing and saving is now. The more time you give your savings accounts and investments to grow, the better. Remember that short-term plans are considered anything under 7 years in length, while long-term plans are those above 7 years. Time is your greatest asset in both investing and saving. It offers you the best bet to grow your money and meet your financial goals. For more information, with help on any of these areas, contact Manhattan Ridge Advisors today.
1 Bank CDs are insured by the Federal Deposit Insurance Corporation and offer a fixed rate of return, whereas both the principal and yield of investment securities will fluctuate with changes in market conditions. Investments offering the potential for higher rates of return also involve a higher degree of risk. Rates of return will vary over time, particularly for long-term investments. Your actual results will vary.