Investing10 min read

Saving vs. investing: which is best for you?

02 saving vs investingAre you unsure about whether to save or invest your money? This guide can help you make an informed decision based on your financial goals and situation. Discover the benefits and drawbacks of both options and find the best path towards building your wealth.

How saving and investing differ

Saving is putting money away in a safe location for short-term use. Investing, on the other hand, is buying assets with the expectation that they will appreciate or generate income. The biggest difference between saving and investing is timing. Something to ask yourself before getting started is: When will you need to use the money? If you need the money in a relatively short period of time — generally five years or less — then saving may be a better strategy.

Many people wonder, should I invest my savings? With savings, you’re putting your money into a risk-free savings vehicle for future use, such as a major purchase. Investing is when you buy assets that will typically appreciate in value or generate income for a longer-term financial goal, such as retirement.

There is generally no risk of losing your money when you save it; however, while investing may yield asset appreciation over time, there is also a risk the asset may lose value. Therefore, here are three things to consider when choosing between saving and investing:

  1. Time horizon. When do you need the money? If you need it within five years, your horizon should be considered short-term, which means you should be saving. Depending on your risk profile, long-term savings, on the other hand, might be invested if you don’t need the money for over five years

  2. Risk vs. return. The purpose of savings is to keep your money safe, but with lower risk comes lower return. The higher risk associated with investing generally means greater returns. For example, putting your money in a high-yield savings account can earn a 3% yield, while the long-term annual growth of the S&P 500 is roughly 10%

  3. Liquidity. Saving means you’ll have near-immediate access to your money, but investing can tie up the money for several years.

Benefits of saving

Saving is best for short-term goals, such as an emergency fund or large purchase. The benefits of saving money in an FDIC-insured bank include:

  • Quick access to funds

  • Minimal risk

  • Earns some interest

  • No learning curve

  • Protected by FDIC insurance, up to $250,000 per deposit or per bank for each account ownership category

Benefits of investing

While saving is great for short-term goals, you get some help from the price appreciation, dividends, or passive income of investment assets to hit major long-term goals. Investing benefits include:

  • Greater return potential

  • Reach long-term goals and build wealth

  • Better protection against inflation

  • Potential to generate income or save on taxes

  • Some investments — such as stocks — can still quickly be liquidated for cash

If you need help investing, consider connecting with FinanceHQ’s trusted financial advisors. These licensed professionals can help you build your financial plan with confidence.

When you should focus on saving money

Saving is great for achieving short-term financial goals. If you are still paying down high-interest debt, saving for certain goals should likely take a backseat until you pay off your debt. That’s not to say you can’t do both — build an emergency fund, if you don’t already have one — but also put as much of your earnings toward your highest interest debt first. Once you have a handle on your debt, here are a couple of instances when saving should be the priority over investing:

  1. You don’t have a cash emergency fund. If you don’t have enough money in a savings account to cover emergencies — such as a job loss, car problems, or unforeseen injuries — you should save at least three months of living expenses as soon as possible

  2. You have major purchases coming up. If you have short-term financial goals you’re looking to hit — such as buying a home within five years or planning a wedding — it’s best to save for those. Investing is too risky if you need the money within a few years.

What about investing your emergency fund? This goes back to the question of, should I invest my savings? You don’t want to invest your emergency fund — this is money that you may need to access quickly and you shouldn’t tie up in the market. Short-term financial goals and plans for major purchases are best met with savings. Savings goals you might have include:

  • Down payment for a home

  • Annual premiums for insurance

  • Home renovations or improvements

  • Vacations

  • Yearly tax bills

Picking a savings account

Finding a savings account is relatively easy. A few must-haves when looking for a savings account should include:

  1. Competitive interest rate. One of the biggest factors for savers is the interest rate offered, also known as the annual percentage yield (APY). You can find a higher rate by looking at online-only banks or high-yield savings accounts.

  2. No monthly fees or charges. A good savings account should offer zero monthly maintenance fees. If the bank you are considering is charging monthly fees, we highly recommend looking elsewhere.

  3. Easy access to money. Make sure you can access your money in the way that suits you, such as account transfers or automated teller machine (ATM) access.

  4. Insured. An account with a bank that is insured by the Federal Deposit Insurance Corporation means you won’t lose money if the bank goes under — generally up to $250,000 per owner, per bank.

  5. Automation. Automatic transfers are an easy way to “pay yourself first” by having a portion of your paycheck go directly into your savings account. Automating your savings plan can ensure you stick to your financial goals.

High-yield savings accounts

It’s worth noting that there are downsides to saving. In particular, the return on savings vehicles may not cover inflation. The spending power of your cash will decline over time if the interest you are earning is less than the inflation rate.

That’s where high-yield savings accounts offered by online-only banks like LendingClub and SoFi come into play. These online-only financial institutions and banks can offer higher rates on savings accounts because they don’t have the same overhead expense of managing branches and physical locations as traditional banks.

While traditional savings accounts will offer an average interest rate of 0.19%, high-yield savings accounts may offer rates of 3% or more. The higher rate offers a greater return, but also helps fend off inflation from eating away at your purchasing power. What about a high-yield savings account vs. investing in stocks? The yield offered by these accounts does rival the dividend yields on key blue-chip stocks. However, these high-yield savings accounts carry less risk and are generally offered by FDIC-insured banks, which means the account balance is guaranteed — up to $250,000 — if the bank fails.

A middle ground: I bonds

Individuals yearning for a higher rate, but still needing to maintain the safety offered by risk-free savings vehicles, may opt for the middle ground between saving and investing: I bonds. Also known as Series I savings bonds, I bonds are meant to be a risk-free way to protect your savings from inflation.

Rates on I bonds can change twice each year — every May and November. The rate change helps offset the changes in inflation. The interest rate on I bonds at the time of writing this article is 6.89%, which is in effect until April 2023.

I bonds, however, are better for savings goals that are at least a year out. I bonds can be cashed in or redeemed after holding them for 12 months. Note that if you hold the bond for less than five years, you lose the last three months of interest.

Also, it’s important to note that I bonds must be purchased through the government’s Treasury Direct website and that generally, only $10,000 worth of bonds may be purchased annually. 

When you should focus on investing money

If you think you’re ready to invest, you should have the following three things:

  • Income

  • Savings and emergency fund

  • No high-interest debt

Shifting your focus to investing comes after you generate income, build a savings plan and emergency fund, and minimize your higher-interest debt. If you’re paying 10% or more in interest on credit cards or other debt, it’s highly unlikely you'll be able to offset those interest charges with investment gains.

Investing is for your long-term goals. Think of investing goals as those that won’t come due for at least five years. Things you may be investing for include:

  • Retirement

  • College costs for your kids

  • Starting a business

If you think you’re ready to invest, then you must also be mentally prepared to handle the market’s ups and downs. It’s true that over longer periods, the stock market handily outperforms savings vehicles, but in the short-term, the value of your investments could fall. Start by familiarizing yourself with stock market basics every investor should know.

When it comes time to invest, there are various investment vehicles to choose from, such as stocks and real estate. The importance of having savings lies in having a source of cash available so you don’t have to sell your investments. Selling your investments too soon means giving up income and return potential. It also means taking a loss if the market is down.

Investing in stocks

When most people think of investing, they consider buying stocks or equities. Buying a stock is the same as buying an ownership stake in a publicly-traded company, such as Apple or Microsoft. Stocks are generally bought via a brokerage account, such as the ones offered by Charles Schwab, E-Trade, and Fidelity.

Whichever brokerage you use, the buying and selling process should be low-cost and easy. Most individuals opt for a taxable brokerage account when they are unsure of their timeline. Taxable brokerage accounts don’t have withdrawal restrictions but also lack the tax advantages of retirement accounts. Note that when it comes to a high-yield savings account vs. stocks, the two are very different. High-yield savings accounts are savings tools, not investing tools.

Investing in real estate

Real estate investing is attractive because it can help diversify your overall portfolio. If you own your home, you are already invested in real estate as a physical asset. If you want a simple way to invest in real estate, consider buying shares in a Real Estate Investment Trust (REIT), which are more liquid, cost a fraction of a physical asset, and do not come with the associated overhead. Individual consumers can invest in REITs in various ways, including purchasing shares of publicly traded REIT stocks, mutual funds, and exchange-traded funds (ETFs).

Investing for retirement

When investing for retirement, the focus is generally on tax-advantaged accounts, such as individual retirement accounts (IRAs) and 401(k)s. A 401(k) is an employer-sponsored retirement account and may offer contribution matches. IRAs are used to help supplement 401(k)s, or as a primary retirement investing account if you do not have access to a company-sponsored plan.

There are two types of IRAs: traditional and Roth. Traditional IRAs allow you to deduct contributions from your taxable income, but you pay income tax when you withdraw the money during retirement. Roth IRAs contributions are made after tax is paid on your income, but any qualified withdrawals made during retirement are tax-free. Note that 401(k)s can also be either traditional or Roth.

Within 401(k)s and IRAs, you can generally invest in a mix of stocks, mutual funds, ETFs, and bonds. There are also retirement account options with higher contribution limits for those that are self-employed or small business owners. Once you put money into your retirement account, however, there are limitations on how and when you can access this money. For example, with traditional 401(k)s and IRAs, if you have to withdraw your money before you are 59 ½ years old, you’ll face a 10% early withdrawal penalty, in addition to having to pay taxes on that cash. You can avoid having to pay the early-withdrawal penalty under certain circumstances. Contributions to Roth versions of retirement vehicles can be withdrawn penalty-free at any time.

Note that even if you are early in the savings process, if your company offers a 401(k) match, it's advisable to contribute the amount that gets you all of the company's match. For example, your company may offer 401(k) matching of up to 4% of your contributions. Therefore, to get the maximum match amount, you should set your contribution rate to a minimum of 4%. Receiving a 401(k) match is an added benefit and should be a focal point whether you are saving vs. investing, unless you are struggling to pay bills.

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Marshall Hargrave
Written byMarshall HargraveContributing writer

Marshall Hargrave is a former SEC-registered investment adviser who is now a strategy consultant for fintech companies.