Saving and investing are both important concepts for building a healthy financial foundation, but they are not the same. While both can help you achieve a more comfortable financial future, consumers need to know the differences and when it’s best to save compared to when it’s best to invest.
The biggest difference between saving and investing is the level of risk taken. Saving usually results in a lower return, but with virtually no risk. By investing, on the other hand, you can achieve a higher return, but you run the risk of loss.
Here are the key differences between the two – and why you need both strategies to build wealth over the long term.
How are saving and investing similar?
Savings and investing have many different characteristics, but they have one common goal: they are both strategies that help you accumulate money.
“First and foremost, both involve putting money away for future reasons,” says Chris Hogan, financial expert and author of “Retire Inspired.”
Both use specialized accounts at a financial institution to raise money. For savers, that means opening an account at a bank or credit union. For investors, this means opening an account with an independent broker, although many banks now also have a brokerage arm. Popular online investment brokers include Charles Schwab, Fidelity and Interactive Brokers.
Savers and investors also realize how important it is to save money. Investors should have enough money in a bank account to cover emergency expenses and other unexpected costs before committing a large chunk of change to long-term investments.
As Hogan explains, investing is money you want to leave alone “to let it grow for your dreams and your future.”
How do saving and investing differ?
“When you use the words saving and investing, people — actually about 90 percent of people — think they’re exactly the same thing,” says Dan Keady, CFP and chief financial planning strategist at TIAA, a financial services firm.
Although the two efforts share some similarities, saving and investing are different in most respects. And that starts with the type of assets in each account.
When you think about savings, think about banking products such as savings accounts, money markets and CDs – or certificates of deposit. And when you think about investing, think stocks, ETFs, bonds and mutual funds, Keady says.
The table below summarizes some of the key differences between saving and investing:
| Characteristic | Savings | To invest |
|---|---|---|
| Account type | Bank | Brokerage |
| Yield | Relatively low | Potentially higher or lower |
| Risk | Virtually no FDIC-insured accounts | Varies per investment, but there is always the possibility that you may lose some or all of your investment capital |
| Typical products |
Savings accounts, CDs, money market accounts |
Stocks, bonds, investment funds and ETFs |
| Time horizon | Short | Long, 5 years or more |
| Difficulty | Relatively easy | More difficult |
| Protection against inflation | Only a little | Possibly a lot in the long term |
| Duration? | No | Depends on the fund’s expense ratios; will also be subject to tax on realized gains in taxable accounts |
| Liquidity | High, unless CDs | High, although you may not get the exact amount you invested in the investment depending on when you cash out the money |
The pros and cons of saving
There are plenty of reasons why you should save your hard-earned money. First, this is usually your safest bet, and it’s the best way to avoid losing money along the way. It’s also easy to do and you can quickly access the money when you need it.
All in all, saving has the following benefits:
- On savings accounts you can see in advance how much interest you will receive on your balance.
- The Federal Deposit Insurance Corporation guarantees bank accounts up to $250,000 per depositor, per FDIC-insured bank, per ownership category. So while returns may be lower, if you stay within FDIC limits, you won’t lose money using a savings account.
- Bank products tend to be highly liquid, meaning you can get your money as soon as you need it, although you may have to pay a penalty if you want to access a CD before its maturity date.
- There are minimal costs. Maintenance fees or Regulation D violation fees (when more than six transactions are made from a savings account in a month) are the only way a savings account at an FDIC-insured bank can lose value.
- Saving is generally simple and easy to do. There are usually no upfront costs or learning curve.
Despite the benefits, saving has some disadvantages, including:
- Returns are low, which means you can earn more by investing (but there’s no guarantee you will).
- Because returns are low, you may lose purchasing power over time as inflation eats away at your money.
The pros and cons of investing
Saving is certainly safer than investing, although it probably won’t result in the most wealth being accumulated in the long run.
Here are just some of the benefits that come with investing your money:
- Investment products such as stocks can provide much higher returns than savings accounts and CDs. Over time, the Standard & Poor’s 500 stock index (S&P 500) has returned approximately 10 percent annually, although returns can fluctuate widely in any given year.
- Investment products are generally very liquid. Stocks, bonds and ETFs can easily be converted into cash on virtually any day of the week.
- If you own a broadly diversified collection of stocks, you can likely easily beat inflation over longer periods of time and increase your purchasing power. Currently, the inflation target that the Federal Reserve uses is 2 percent, but this has been much higher for the past two years. If your return is below the inflation rate, you will lose purchasing power over time.
While there is the potential for higher returns, investing has quite a few drawbacks, including:
- Returns are not guaranteed and you are likely to lose money at least in the short term as the value of your assets fluctuates.
- Depending on when you sell and the health of the economy as a whole, you may not get back what you initially invested.
- You’ll want to keep your money in an investment account for at least five years, so you can hopefully ride out any short-term downturns. In general, you want to keep your investments for as long as possible, and that means not having access to them.
- Because investing can be complex, you’ll probably need to do some research before you start, but once you get started, you’ll realize that investing is doable.
- Brokerage account fees can be higher, but many brokers now offer free trades.
So what is better: saving or investing?
Saving or investing is not better under all circumstances, and the right choice really depends on your current financial position.
When to save money
- If you need the money in the coming years, a high-yield savings account or money market fund is probably best for you.
- If you haven’t built an emergency fund yet, you’ll want to do so first before diving into investing. Most experts suggest setting aside three to six months’ worth of expenses (or more) in an emergency fund.
- If you have high-interest debt, such as a credit card balance, it’s best to work on paying it off before investing.
When to invest money
- If you don’t need the money for at least five years (or more) and you’re willing to take some risk, investing the money will likely yield a higher return than saving it.
- If you qualify for an employer match to your retirement account, such as a 401(k). It is crucial that you contribute enough money to ensure that you receive the match because the match is like free money.
If you’ve built an emergency fund and don’t have high-interest debt, investing your extra money can help you grow your wealth over time. Investing is crucial if you want to achieve long-term goals such as retirement.
Real-world examples are the best way to illustrate this, Keady says. For example, if you need to pay your child’s college tuition in a few months, it should be in the form of savings: a savings account, a money market account, or a short-term CD (or a CD that is set to mature when it is needed) .
“Otherwise people will think, ‘You know, I have a year and I’ll buy a house or something, maybe I should invest in the stock market,’” Keady says. “That is really gambling at that moment, instead of saving.”
And the same goes for an emergency fund, which should never be invested but should be kept in savings.
“So if you get sick, lose your job or whatever, you don’t have to go into debt,” says Hogan. “You have money that you have deliberately set aside as a buffer between you and life.”
And when is investing better?
Investing is better for longer-term money – money that you try to grow more aggressively. Depending on your level of risk tolerance, investing in the stock market through exchange-traded funds or mutual funds may be an option for someone looking to invest.
When you can keep your money in investments for longer, you give yourself more time to weather the inevitable ups and downs of the financial markets. Investing is therefore an excellent choice if you have a long time horizon (ideally many years) and do not need to have access to the money quickly.
“So if anyone is getting into investing, I would encourage them to really look at growth stock mutual funds as a great way to get a foothold,” says Hogan. “And really start to understand what’s going on and how money can grow.”
In short
Although investing can be complex, there are simple ways to get started. The first step is to learn more about investing and why it could be the right move for your financial future.
You may want to consider working with a financial advisor to make sure you’re on the right track. Bankrate’s financial advisor matching tool can help you find an advisor near you.
— Bank interest Rachel Christian contributed to an update to this story.
