We know, you’ve heard it many times before – to successfully plan for the future, you must live below your means and use the remainder of your income to save and invest. [Editor’s Note: If you’re not sure whether you’re living within your means, check out the GoGirl Guide to Making a Budget.]
But, what’s the difference between saving and investing and what are the circumstances in which you should be doing one versus the other?
Simplest things first: Why Save?
Saving is a way to create a cushion of cash that protects you from the danger of relying solely on your income (or, credit cards!) to cover your financial needs.
Saving for an emergency fund means you have cash set aside to be spent only on designated large purchases (such as a car, or a new kitchen appliance) or emergencies (such as the breakdown of the aforementioned car or kitchen appliance!)
As you well know, proceeds for some of life’s major purchases – e.g. a down-payment for buying your first home – will likely not be met by your regular income alone. So, you have to save up by setting aside money over a number of months or years. And once you are in your house, if your roof is leaking and needs to be replaced immediately, meeting that emergency expense is much easier if you had the foresight to set aside some cash in a safe place where it wouldn’t be spent.
By putting your money in an interest-bearing savings account, you can accumulate additional cash even if you are only investing small sums due to the power of compounding interest.
How Much Money Should I Have in My Emergency Fund?
The oft-repeated rule is that your cash emergency fund should cover six months (or more) of expenses. However, if you’re working towards paying down debt, or have umpteen other priorities, this might not be feasible. Manisha Thakor refers to an emergency fund as an “uncertainty fund”, and, therefore important questions to ask yourself when deciding how much to put aside relate to how much uncertainty you have in your life (e.g. owing to inconsistent income) and what measures you’d take if you faced a major issue such as an unexpected medical bill.
Once you have reached your emergency savings goal and also accounted for any other near-term goals [3-5 years out] that require cash, you can start to think about directing the money you’re setting aside into investments.
What is the Difference Between Saving and Investing?
Though they are often used interchangeably, saving and investing are not synonymous. When talking about saving in the context of finances, it simply means that you are setting aside money not to be spent. Investing means that you are putting money somewhere such that you expect that investment to rise in value so that you achieve a profit, or at least grow in line with inflation.
This is a very important distinction to keep in mind because when you save money, your primary goal is preservation rather than growth. However, when you invest, you are spending money with the expectation that you will receive back your original amount and then some.
What are the Benefits of Investing?
Good question. Many people, and especially women, feel uncomfortable and intimidated by this topic. Well, let’s try and break down the barriers because investing is one of the most important components of building wealth and establishing financial security.
Investing provides the opportunity for your money to grow because the asset that you purchase (whether it is a mutual fund, a share of stock in a company, a piece of real estate or something else):
- hopefully becomes more valuable over time (i.e., someone else is willing to pay more money for it for whatever reason); and/or
- provides income for the duration that you hold it (i.e., a stock paying a dividend, a bond paying a coupon or a tenant paying you rent).
As mentioned above, growing your money is important not only for building wealth but for keeping up with inflation. The cost of many things (e.g. consumer goods and housing) increases over time which erodes your money’s purchasing power. For example, suppose that 20 years ago you had saved $1,000 and put it under your mattress. Today, you would have $1,000 but $1,000 20 years ago had much greater buying power than it does today – look at house prices from 20 years ago.
However, if you had invested that money in stocks, real estate or another type of investment with higher expected returns so that it had grown in line with, or beaten, inflation, you would be able to purchase the same amount of goods as you would have been able to in 1993, and hopefully even have something left over.
Of course, the flip side is that when you save money, while you don’t have much potential for growth, you also don’t have much risk of loss. Firstly, checking accounts and interest-bearing accounts don’t risk the capital (i.e. the money you are putting aside) but also because FDIC-insured banks provide protection on up to $250,000 worth of deposits in savings and checking accounts.
This is not the case with investing. When you invest, you have the opportunity to achieve higher returns but this comes with higher risk meaning you could also lose your money. The key is therefore to understand your own risk tolerance and also the risk inherent to any investments you are considering.
In our next GoGirl Guide, we’ll tackle this in more detail and help you think about where to invest.
This website and the information provided herein has been prepared solely for informational purposes and does not constitute investment advice nor should be construed as investment advice. Readers should consult with professional advisers as deemed necessary for assistance when making investment decisions.