Saving Vs. Investing: What’s The Difference And How Do You Choose?

Together, saving and investing build the foundation for your financial future, but they’re completely different tools that are most efficient when used at the right time. Understanding the difference between saving and investing can have a major impact on your money management.

Let’s clarify the characteristics of saving and investing, discuss when it’s typically the right time to do one or the other, and review your investment options.

What’s The Difference Between Saving And Investing?

The primary difference between saving and investing your money comes down to purpose, risk and liquidity. When you’re saving money, you’re setting funds aside in an accessible, secure place – such as a savings account or certificate of deposit (CD).

In these accounts, the risk that your money will decrease in value is low, and you can easily retrieve the funds as needed. The funds are therefore “liquid,” or easy to access.

Investing, on the other hand, requires taking on some risk because you’re essentially trying to grow your money by purchasing assets that will ideally – but not necessarily – increase in value over time.

Investing Vs. Saving: An At-A-Glance Comparison

Let’s take a look at some of the key differences between saving and investing money.

An Overview On Saving

Savings accounts are ideal for short-term financial goals or emergencies. The money in savings accounts is more liquid than money placed into investments. For example, if you plan on making any major purchases soon or you’re saving for a down payment on a house, a savings account could be the best option for your money.

Additionally, an important aspect of financial wellness is being prepared for emergencies. Most financial experts advise having enough money saved in an emergency fund to cover 3 months’ worth of expenses.

If you’re just starting to save, we recommend an initial goal of $1,000 and working your way up to 3 months’ savings in reserve. That way, if you need money for an emergency, you can tap into your emergency savings and hopefully avoid going into debt.

Let’s review the risk and liquidity of a savings account, whether it’s a CD, money market account, high-yield savings account or traditional bank savings account.

Risk

Saving money comes with virtually no risk. Most savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000. This insurance guarantees that the funds in your savings account are protected in the event your bank fails.

Low risk also means your savings account offers minimal gains. Money sitting in a low-interest savings account can lose value due to inflation over a long period of time, even if the balance of your account never decreases.

Alternatively, you might consider a high-yield savings account – usually offered by online banks, with a high annual percentage yield (APY) rate that amounts to a huge difference in interest earnings.

Liquidity

Money can be pulled out of savings or CDs when needed or after a short probationary period. If you need to access your money easily, savings accounts are your best option because some CDs have penalties for withdrawing funds earlier than you agreed to when you opened the account.

Typically, you’ll want a solid savings account established and your high-interest debt paid before you start investing. Don’t have an emergency fund? You can easily start one using the Smart Savings feature from Rocket Money℠.

An Overview On Investing

Investing, more so than saving, is geared for achieving long-term financial goals like retirement or building a college fund. Common places to invest your money include the stock market and real estate. The longer your money is invested, the more potential it has to multiply.

However, investing doesn’t have a guaranteed return beyond protection from institutional failures. If the holdings go down in value, you may lose money from your investments. Unlike saving accounts, probable risk and lack of liquidity are important to consider when investing.

Risk

Investing can provide higher returns than a standard savings account, but with those returns comes greater risk. The stock market is susceptible to ups and downs, so money may be lost as a result of investing, and returns can vary depending on the specific investment.

However, investing can ultimately, over time, bring greater rewards than saving. Generally speaking, the longer you keep your money in your investments, the more you can recover from any rockiness in the stock market.

Liquidity

You can buy and sell investment assets, but you may incur some extra costs or fees if you remove money before investments come to term. For example, if you have a retirement account like a 401(k) or an IRA, money earned can’t be withdrawn from those accounts early (before age 59½) without paying a 10% penalty.

An exception to this rule might be made in specific instances like buying your first home.

Should You Save Or Invest Your Money?

Saving and investing both contribute to your general financial wellness, but they do so in different ways.

When You Should Save

If you have short-term financial goals or need to store away money for emergencies, you most likely should put money into savings. Let’s look at a few scenarios where it may be more beneficial to consider putting your money into savings rather than investments:

●      You haven’t built up your emergency fund. An emergency fund is about 3 to 6 months’ worth of your living expenses in a savings account that you can access in case of an emergency. Having an emergency fund can prevent you from going into debt if certain situations arise, like losing your job or getting hit with expensive medical bills. It’s a good rule of thumb to establish an emergency fund before starting to invest.

●      You’ll need the money within 5 years. If you’re saving for a down payment, wedding or other large purchase you’ll make in the short term (3 to 5 years), you should keep some money in a savings account. You can go with a standard savings account through a bank, a high-yield savings account or a money market account.

●      You need to pay off high-interest debt. High-interest debt (any debt with an APR above 7% – 8%) can continue to be a financial burden the longer it takes to pay off. You can get a better return paying off credit card debt or other forms of high-interest debt rather than investing the amount you owe.

When You Should Invest

Typically, you’ll want to invest for long-term goals, ones that are at least 5 to 10 years away. The longer you keep your money in investments, the more time you have to ride out the highs and lows of the stock market and end up with greater return. If you don’t give your investments a few years to bear fruit, or you try to time the market, you may end up with a significant loss.

Here are some instances when it would probably be a good idea to invest rather than place your money in a savings account:

●      You don’t need the money in the short term. If you have an established emergency fund and can afford to be patient, it likely makes more, too. sense to invest instead of saving.

●      You’re paying off low-interest debt. Unlike with high-interest debt, you can focus on investing with low-interest debt such as student loan debt or mortgages. It doesn’t hurt to pay off the low-interest debt first, but it’s possible to still earn returns on your investments and maintain your low-interest debt payments. Just make sure your budget allows for it. (You can easily set up and check your budget using Rocket Money.)

●      Your 401(k) is eligible for an employer match. If your employer provides a match on a 401(k), 403(b) or other retirement accounts, this is a worthwhile investment. By contributing enough to get the full match, you’re collecting essentially free money.

●      You have long-term goals that require a high return-on-investment. Investments can be helpful for large expenses that occur down the road. If you’re planning for events such as retirement or a child’s college education, you’ll likely want to invest for several years. A long-term investment can offer a greater reward than savings, although trying to save some money for these milestones is a good idea, too.

Savings Vs. Investment Ratio

Of course, you don’t always have to choose between saving and investing your money. If it’s a manageable financial strategy, you may have the option to save and invest at the same time. But as with most aspects of financial planning, the ratio of money you choose to save versus invest depends on your particular situation and your short- and long-term goals.

Before investing, it’s probably a good idea to build up your savings and emergency funds. A budget can help you keep track of how much money you’re saving every month, and it can help you understand how much you have left over to potentially use for investments.

Most of the time, you probably don’t want to invest more money than you’re saving. That’s because savings and emergency accounts provide financial support you may need if something unexpected happens, like a job loss or medical emergency.

Investments can also take a while to come to fruition, so you likely won’t be able to access the funds at a moment’s notice.

If you want to have the money available to save and invest simultaneously, sticking to a strict budget is in all probability your best strategy.

The Bottom Line On Saving Money Vs. Investing

You can create a healthy financial future through saving and investing. By planning carefully based on your needs, saving for short-term goals and investing for long-term growth, you will be well on your way to making your money work for you.

Take the heavy lifting out of your financial planning and let the Rocket Money app put your savings on auto-pilot. Start today with Rocket Money.