If you want to get ahead financially, you can’t spend every dime you earn. You need to keep some money for yourself. The question is, what should you do with the money you aren’t spending?
You generally have two choices: You could save it, or you could invest it. Saving and investing are not the same thing, and you’ll need to decide which approach is the right one for you. This guide will help you make your choice.
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Saving vs. investing
To decide if saving or investing is the right thing to do with your money, you’ll first need to understand the difference.
Saving money simply means keeping money that you don’t spend. This money is usually intended to be used for some specific financial goal you’re hoping to accomplish soon, such as making you less financially vulnerable in case of emergencies or saving for a big purchase you can’t afford to pay for all at once.
Usually, the money you save should be accessible to you and you shouldn’t take risks with your savings. You could save money in your regular checking account simply by not spending everything you deposit, but usually you’ll want to keep your savings in a separate account. You could, for example, choose a high-yield savings account that’s FDIC insured. FDIC insurance protects the funds so you don’t lose the money in case the bank goes under, and the high-yield savings account would allow you to at least earn a little bit of interest without taking any risks.
Investing, on the other hand, means buying assets with the goal of earning a return on your investment and, ultimately, growing your wealth. You could invest for the long term or the short term, just as you could save for long-term goals or short-term goals. But, when you invest money, you generally take a little more risk in exchange for the chance of a reasonable or good return on your investments.
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Investing money is necessary if you want to get ahead financially. That’s because when you simply save money by putting it in a savings account — or by putting it under your mattress or into a safe deposit box — your money usually loses buying power gradually thanks to inflation. If you buy investments, on the other hand, the goal is for your investments to produce enough of a return that your money doesn’t just keep pace with inflation — it grows.
You could invest in lots of different things, although investing in the stock market is often the best approach because diversified portfolios of stocks have historically performed better than other investments. You could also invest in real estate, gold or silver, antiques, or artwork. Anything you’re buying with the primary goal of making money off of it could be considered an investment (although some investments are riskier than others).
Investments carry inherent risks because your investment could gain or lose money. When you’re simply saving money, you don’t want to take a chance on losing it. To minimize the risk of investing, plan to keep the assets you’re buying for a longer time period. That way, there’s time for your investment to increase in value — and if there’s a short-term downturn, you’ll have time for the investment to recover rather than selling it and locking in that loss.
Should you save or invest?
Unfortunately, there’s no one right answer to the question of whether you should save or invest. That’s largely because the answer is that you need to do both. However, the amount of money you should dedicate to saving versus investing varies depending on your current financial situation, your risk tolerance, and your long-term goals.
Typically, you should accomplish certain savings goals before you begin to invest money. However, there are some exceptions to this general rule.
For example, you usually should save at least a small amount of money you can access in case of emergencies — and you should do this first before investing because you don’t want to be forced to sell investments or go into debt to cover unexpected costs. But, you may not want to devote all your cash to saving an emergency fund if you could invest some of your money in a 401(k) and get matching funds from your employer at work.
The best solution, for most people, is to save some money and invest some money. If you’re able to use 20% of your income towards saving and investing, for example, you might decide to invest 15% of your money in stocks and bonds with the goal of building a big portfolio for retirement — and to save the remaining 5% for short-term goals such as buying a house next year, covering emergency costs, or paying for a family vacation.
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How to decide whether to save or invest your money
If you need to both save and invest, how should you decide whether a particular dollar you aren’t spending should be saved or should be invested? Some of the key factors to consider include:
- What financial goals are you currently prioritizing? Think about what’s most important right now to get your financial life in order. Do you need to put aside money for emergencies so you won’t keep going into credit card debt? Are you focused on saving for college for your kids who will be attending school in 10 years? Are you worried about what you’ll live on in retirement? The answer will be different for everyone, so you need to know your own priorities to decide whether to save or invest.
- When will you use this money? If you’re putting aside money for a financial goal you hope to accomplish within a short time frame, you should save the money. This means you won’t try to earn the best rate of return, but you’ll instead put the money somewhere safe where you can access it quickly. You don’t want to invest money you’ll need within the next few years because it’s so important to be able to keep investments for a long time to minimize risk. Typically, if you’ll need the money within around two to five years, save it.
- What do you want this money to do for you? If you’re hoping the money will grow and produce a good return for you, you should invest it. If you’re putting aside money for retirement, it would be almost impossible to save enough money to support yourself if you don’t invest and earn returns that help your money grow. But, if you’re hoping the money will protect you in case of emergencies or you can use it to accomplish something soon, such as paying for a wedding or vacation next year, you should save it.
- Do you understand how to invest? When you invest, you want to evaluate the risk and make sure it’s reasonable. To do this, you need to know what you’re investing in, how and why your investment could increase in value or lose value, and how you can reduce risk by diversifying your investments. Until you have at least a basic understanding of assets you can invest your money in, you’re better off saving.
Both saving and investing are important
Ideally, you should both save and invest some of your money from every paycheck. Then, you can accomplish all different kinds of important financial goals. You can keep some of your money safe and accomplish short-term goals with it while also building an investment account that works for you to produce returns and help you build a more secure future.
View more information: https://www.fool.com/the-ascent/buying-stocks/articles/saving-vs-investing-which-is-right-approach-for-you/